Policy framework for China's equity market needs a makeover

By Yi Xianrong Source:Global Times Published: 2018/6/13 22:38:40

Illustration: Luo Xuan/GT

The WTO was established with the purpose of forming an integrated, active and durable multilateral trade mechanism by cutting tariffs and lowering barriers among its members.

China's economy started to take off after it gained access to and fully embraced the international market. Since 2001, when China joined the WTO, foreign investment has flowed in, and products made in China prevail around the world.

The domestic economy has grown rapidly and the living standards of the Chinese people have risen. These gains are inseparable from the nation's entry into the WTO.

However, the WTO General Agreement on Tariffs and Trade framework did not include financial services. So China left the door half-closed for the financial sector after joining the WTO.

The financial market in China still remains at a low opening level, which stops the yuan from being fully internationalized. Also, this lack of openness has dragged down the financial sector, which cannot keep up with the pace of the booming real economy.

China has opened to the world trade system. The next step, also a key one leading to a prosperous financial market in China, is opening to the world financial system.

To join the financial version of the WTO requires three steps. First, the IMF in 2016 added the yuan to the Special Drawing Rights (SDR) basket. Second, earlier this month, more than 200 Chinese A-shares were included in the MSCI indexes. Third, Chinese bonds are set to join the Bloomberg Barclays Global Aggregate index in 2019.

The SDR inclusion has made the yuan into a global reserve currency. The yuan's internationalization has become more achievable with the IMF's endorsement. This is having a far-reaching effect on the further opening-up of the financial market.

As for the MSCI, in the short run, the amount of foreign capital flowing to China will be too low to influence A-shares, since these shares only represent 0.39 percent in the MSCI emerging markets index. Investors cannot count on the inclusion giving a strong boost to the Chinese stock market. Despite this, the MSCI move is still a milestone marking China's entry into the international financial system. South Korean stocks, for example, surged after being included in the emerging markets index.

Although the ultimate impact of the MSCI move is still uncertain, the inclusion of A-shares in the MSCI index can be said to have kicked off the internationalization of the Chinese stock market. The A-shares' weight will rise gradually, and they may eventually account for 18 percent of the emerging markets index. This will mean 200 billion to 400 billion yuan ($31.23 billion to $62.46 billion) in foreign capital flocking into the A-share market over five to 10 years.

It's a simple calculation, if an uncertain one. The A-share market is backed by the world's second-largest economy, with the real economy vigorously developing. It's appealing for international investors. These investors should be encouraged to gain a better understanding of the Chinese stock market.

Stock markets worldwide have witnessed rapid gains recently. Even the Japanese stock market has picked up after more than 20 years of sluggishness. But things have been very different in the Chinese stock market.

From 2003-2013, China's economy soared and real estate prices rocketed. The nation's stocks, however, went the other way. The Shanghai Composite Index started at 2,200 points in 2003, and that's where it was again in 2013.

In 2015, stocks surged and then plunged, causing huge losses for retail investors. At the moment, the Shanghai Composite Index is hovering at about 3,000 points.

The fundamental reasons are institutional weaknesses and a real estate market that sucked liquidity from the stock market. The government took on too much responsibility for managing the stock market, reducing the role of market forces. In a case such as this, a prosperous stock market will be difficult to achieve.

The Chinese stock market is in fierce competition for funds with the real estate market, which is a more profitable alternative and one that's favored by more investors. The government over the years, using administrative orders, created a highly speculative real estate market.

Investors commonly believe that buying a house means a guaranteed windfall profit. Real estate investors in China have achieved 10- and even 20-fold gains in the past decade. Declining trading volumes have also undermined the stock market. The policies that shape and govern China's stock market must adjust and improve the market environment. Otherwise, the stock market in China will go back to where it started.

The author is a professor with the School of Economics at Qingdao University. bizopinion@globaltimes.com.cn


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