Chinese President Xi Jinping owes his central bank governor a debt of gratitude. Last week looked to be ending on a downbeat note as the much-heralded launch of the Shanghai-Hong Kong stock exchange link seemed to have fizzled. Rather than rush to bet directly on China's growth story for the first time, investors bought up less than a quarter of the link's stock quotas.
By Friday evening, attention had shifted to a People's Bank of China rate cut, the first in over two years. Just as the Bank of Japan cheered the world on Oct. 31 with its own stimulus move, the PBOC's bombshell refocused attention on attempts to stabilize the world's second-biggest economy. Now all anyone wants to talk about is when China's central bank will intervene again, not why the exchange link has turned out to be such a dud.
The latter may be the more important question. There's little doubt that Governor Zhou Xiaochuan's shock-and-awe move was the right one. Given China's public debt burden and default risks among state-owned enterprises, a looser monetary policy makes sense. But Zhou is merely treating the symptoms of China's troubles, not the underlying causes. Until Xi addresses China's structural weaknesses, foreign investors will have good reason to steer clear of the equities on offer in Shanghai.
Think about it. Why should any self-respecting pension fund manager barrel into China's notoriously opaque and fraud-riddled stock market when bad loans are surging, a property bubble seems ready to pop and growth is slowing? For all Xi's pledges to rebalance the Chinese economy, the country remains an export machine -- one that confronts weak international demand, competition from a plunging yen and a Federal Reserve anxious to hike interest rates. Chinese shares surged to three-year highs on expectations that foreign asset managers would be clamoring to buy last week. Those who did so may well have been reckless, not brave.
Beijing still needs to clarify the mechanics of its so-called through train. Confusion surrounds everything from the tax treatment of trading positions, to how transactions are executed by brokers in Hong Kong, to how easily investors can get their money out of the scheme. More importantly, Xi has done little to clear away the opacity that plagues much of China's economy. If he truly wants to increase the role of the private sector and embrace international norms of corporate governance -- both indirect goals of the exchange link -- he's going to have to do more than put a few shares up for sale. China would have to provide far more transparency and legal options for shareholders than the government has ever tolerated before. Authorities would have to allow for a more activist media, including foreign journalists, to police the process.
Is Xi ready for that? Hardly. For all the excitement about last month's party plenum -- where Xi's government pledged to strengthen the rule of law -- international investors have no way to hold Chinese companies accountable, no matter how many shares they own. Oddly, the stock link is only increasing the relative attractiveness of Hong Kong, despite recent student protests there. (Hong Kong stocks surged the most in a year on Monday.) Trust and institutional credibility are irreplaceable.
China's other experiments with opening up are running into similar problems. Even the Shanghai Free Trade Zone, unveiled a year ago with great fanfare, has been a disappointment. Big promises to cut red tape, allow markets to set interest-rate levels and offer a wider range of trading instruments such as derivatives haven't been met in practice. Beijing did itself no favors by overselling what it was willing to tolerate in Shanghai.
Xi deserves credit for attacking official corruption. But high-profile prosecutions of Party officials can't replace the hard work of retooling China's financial system. There's as yet scant evidence Xi is ready to open China's capital account, free interest rates, allow entry to new banks or create mechanisms to get bad loans off balance sheets. If his government doesn't pick up the pace on such reforms, all Zhou's rate cut will do is encourage a fresh round of risky investments. Good luck getting anyone to buy in then.
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