How the stock market rout will slow financial deregulation

July 23, 2015 09:49
Central bank chief Zhou Xiaochuan is pressing for faster opening of the capital account but there are growing voices calling for a more conservative approach. Photo: Bloomberg

China’s recent stock market rout, followed by unprecedented government intervention, will undoubtedly have a profound impact on future policy mapping.

What is most likely is that the liberalization of the financial market will witness a slowdown, if not a setback.

The more than 30 percent slump in the stock market in less than a month was clearly a disaster.

The market regained some ground only after the government rolled out massive rescue measures by mobilizing state-controlled resources.

Now that market volatility has eased, regulators and policymakers can sit down to draw on the lessons of the crisis.

The meltdown will reshape their understanding of China’s financial market and change future policymaking.

First to be tackled is likely the increasing conservatism toward the opening of the capital account.

Earlier this year, central bank governor Zhou Xiaochuan said on several occasions that China must pick up speed in that area.

The People’s Bank of China is planning to launch a trial program that will allow individuals in the Shanghai free trade zone to invest in overseas markets directly for the first time.

Under the program known as QDII2 (qualified domestic individual investor), the annual purchase ceiling of US$50,000 worth of foreign currency is expected to be scrapped.

It was reported that the program is very likely to be launched in the first half.

Although there is no sign that the plan will not proceed, it's clear policymakers are reconsidering the timing after the stock market rout exposed the fragility of the Chinese financial system.

They're realizing that China is not ready for the impact of international money under a fully open capital account.

A controlled capital account shielded China from the 2008-2009 global financial crisis.

Now there are voices calling for a gradual and conservative approach to financial deregulation.

Also to be affected is the progress of the IPO registration system which replaces the present approval-based regime.

It will take time for the registration system to take hold with regulators wary of the potential negative consequences of deregulation on IPOs.

Another immediate action is a crackdown on illegal margin financing which caused the frenzied rise of the Shanghai stock market before it collapsed.

China authorized margin financing in 2010 and now requires investors to have had an open account at a registered securities company for at least six months, with the value of cash and stock in the account at least 500,000 yuan.

However, this requirement was not strictly followed by securities brokers.

Worse, many individual investors not eligible for the program heavily borrowed money from banks, trust funds and online financing channels to buy stocks.

The leverage ratio of the financing can be up to ten times.

It's understandable that regulators are working hard to ban shadow margin finance.

At the same time, they will control legal margin lending by bringing down the leverage ratio to parity.

Increased regulation of the online financing industry, which channeled speculative capital to the stock market, is also likely come with deleveraging.

It's fair to say that the stock market crisis pushed top policymakers toward controlling the internet financing industry instead of liberalizing it.

This change is reflected in recent guidelines.

The document specifies the government agencies that supervise the sector and sets strict limits on some popular forms of online financing such as peer-to-peer platforms.

These platforms are envisioned to act as information providers rather than financing tools.

Lastly, as a result of the stock market crisis, policymakers could return to the old way of spurring the economy by fiscal means.

It will be no surprise if the government approves more major infrastructure projects in the second half of the year.

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The writer is an economic commentator. He writes mostly on business issues in Greater China.