Stock market rout stalls China's march to liberalisation

Chinese stock market. (Reuters)

Chinese stock market. (Reuters)

As China’s central bank chief looked out on the annual gathering of his nation’s legislature in the Great Hall of the People in March, he had every reason to look forward with confidence, even optimism.

True, the world’s second-biggest economy was decelerating. But the governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, was finally making headway with long-sought financial system reforms designed to put China’s debt-fuelled, $10-trillion economy on a more stable footing. He said he would try to eliminate caps on bank deposits in 2015, furthering the liberalisation of interest rates.

Days later, he told International Monetary Fund head Christine Lagarde that China would make the yuan more freely usable outside China – all part of a drive to make it an official IMF reserve currency.

Fast-forward four months, and Zhou finds himself caught in a stock market rescue that smacks of meddling.
A nearly four-week rout that wiped out $3.5-trillion in share market value has forced the central bank to extend funds to a broker lending facility and threatens to undermine support for his market liberalisation agenda.

“For better or worse, this will strengthen the forces who want to slow governor Zhou’s march to a more open capital account,” said David Loevinger, an analyst at the fund manager TCW. “Always worried about losing control, this could give Chinese leaders cold feet about moving to a more capital markets-centred financial sector.”

Lomgest-serving Zhou, 67, has earned distinction as the G-20’s longest-serving central bank chief and in helping to keep China out of a financial crisis for the past decade. The governor, whose term began in 2002, ended a decade-old currency peg to the dollar, expanded the bond market and gave banks more freedom to set lending and deposit rates.

Michael Spencer, the chief economist and head of research, Asia Pacific, at Deutsche Bank AG, said, the PBOC had built a money market infrastructure in line with the world’s leading central banks. “They have built up the full range of policy instruments, very similar to the ECB [European Central Bank], in fact.”

That moves China closer to a day when money is priced according to risk and directed by market forces, rather than channelled to state-owned enterprises (SOE) at the government’s bidding.

President Xi Jinping and Premier Li Keqiang have mapped out an agenda that seeks to boost the role of markets in the economy. This year, Zhou and Li had set their sights on getting the yuan admitted to the IMF’s special drawing rights basket, which would lock in financial reforms to satisfy inclusion rules.

The stock market rout “will inevitably weigh on the pace of reforms such as capital account liberalisation and domestic financial re-engineering”, said Angela Beibei Bao, an analyst with the Rhodium Group. “Reformers must become more savvy, learning to handle restructuring pains with sophistication, instead of the impetuous, ham-fisted responses we have seen recently.”

Still, the steepest rally since 2009 on Thursday showed the markets are finally responding to the government’s multipronged effort to halt the slide. The Shanghai composite index closed 5.8% higher, paring its loss since June 12 to 28%.

Wang Tao, the chief China economist at UBS Group AG, said Zhou’s reform agenda wouldn’t be derailed by the equities turmoil. “Financial reforms are moving ahead, and will move ahead,” she said. “Other reforms, fiscal and SOE, for example, are critical for the success of financial sector reform.”

Zhou faces the task of keeping his reform agenda on track amid intensified anxiety over the risks it could unleash.

Rajiv Biswas, the Asia-Pacific chief economist at IHS Global Insight, said, for the moment, though, he would need to focus on crisis management and monetary stimulus. Capital account convertibility was “likely to be delayed due to the stock market crash, as fears of capital flight will be a key concern constraining near-term reforms,” he said. – © Bloomberg