China’s stock market crash: Liberalisation cannot be fully controlled
Visiting China last week to discuss finance with regulators, officials and industry people in Beijing and Shanghai was a timely reminder of the country’s economic vitality. All the facts confirm this – China is the world’s second largest economy (probably the largest on a purchasing power parity basis), and it is growing at twice the rate of the fastest-growing western economies.
The country is firmly embarked on a path of economic and financial liberalisation in the measured and controlled Chinese way. The RMB is now fully convertible on the current account and is well on the way to becoming so on the capital account too. And on top of this the Chinese market is more open to foreign institutions. While there is still some way to go in this last point, Chinese institutions are making their presence felt in global markets.
The push for liberalisation was tested in a big way while I was in China. By June, the Shanghai stock market had grown by 150 per cent in a year, driven by retail investors, and often with borrowed money. Hairdressers and taxi drivers jumped on the bandwagon and suggested that their customers do the same.
Of course, the correction had to come – and prices have fallen 30 per cent since mid-June. This was portrayed as a disaster in the media, although in reality it was a correction familiar to western markets. Some held the government to be responsible and it announced a package of measures to stabilise the market. They did not work and the market continued to fall.
So there are two lessons for both government and investors to learn: investing in the stock market with leveraged borrowed money is bound to end in tears, and market forces can easily trump government action. Will this cause a rethink on the pace of reform? Quite possibly yes, at least in the short term.
But the roadmap remains, albeit with some road works taking place. The Chinese market will open up, offering huge opportunities for British firms. Equally importantly, the Chinese government is helping businesses globalise through a range of initiatives, including the Silk Road Fund and the Asian Infrastructure Investment Bank. The size of China’s economy means that these developments can be partly on Chinese terms – but the stock market correction is a lesson to China that liberalisation cannot be fully controlled, and that the country must make its own substantial adaptions to manage a market rather than a command economy.
This point is a central conclusion of an important new report by the Atlantic Council (Renminbi Ascending: How China’s Currency Impacts Global Markets) on the implications of internationalising the RMB. The report shows that China must have a much greater role in the international financial regulatory system and must take the necessary internal measures to cope with a convertible currency. For western countries, particularly the US, it also highlights how we need to fully understand and adapt to the change in the world order.