China putting cart before horse
As China’s markets gallop into the global sphere, it’s hard not to think about horses. Few metaphors better capture MSCI Inc.’s decision to add mainland stocks to the world’s most influential emerging-market index.
Chinese reformers see inclusion in the MSCI as a Trojan Horse. Joining the World Trade Organization (WTO) in 2001, for example, was about enlisting outside forces to open and modernize the economy. So was getting the yuan added to the International Monetary Fund (IMF)’s elite reserve-currency club. Letting foreign authorities inside China Inc.’s walls, they believe, leaves Beijing no choice but to raise its game, and MSCI is the next step. President Xi Jinping’s government won’t find it easy to close the stable door once it’s open.
But there’s another metaphor Asia must consider as global indexes are off and running after Chinese shares. Is Beijing putting the cart before the proverbial horse? And will economies from Singapore to India be taken along for a wild ride?
The regional implications of China’s growing stock footprint haven’t been widely explored. The risks associated with, say, Beijing’s debt bubble are well recognized. But increasing foreign exposure to China’s corporate imbalances raises the stakes for Asia.
Bulls say it’s high time China’s A-shares, the second biggest market by capitalization after the US, got MSCI’s good-housekeeping seal—well, 222 out of 448 of its listed companies for now.
MSCI, they argue, is prodding mainland regulators to stop companies from suddenly halting stock trading (more than 100 are currently suspended), increase investors’ ability to pull cash out of China and improve the market plumbing between Shanghai, Shenzhen and Hong Kong. MSCI, in other words, still holds the riding crop and the leverage.
Here’s the problem: WTO inclusion didn’t change China, as much as China whipped the international trade system to its own liking—something Donald Trump voters talk of virulently. The IMF pulling the yuan into its “special drawing rights” circle in 2016 didn’t stop Beijing from imposing capital controls recently. MSCI may share this buyer’s remorse, should Chinese officials rewrite the rules rather than play by them. It’s troubling, though, to see how Beijing appears to see capital liberalization as the reform, not the other way around.
Nothing about MSCI embracing domestic A-shares makes China’s financial system sounder, the government more transparent or less corrupt, companies more shareholder-friendly or the shadow-banking menace any less of a threat. That requires significantly heavy lifting in Beijing—scaling back the dominance of state-owned enterprises, making space for a private-sector big bang and curtailing duelling bubbles in debt, credit, assets and pollution.
Little such lifting is afoot, which means domestic reform is vastly trailing China’s haste to play a bigger role overseas. The same could be true, frankly, with Beijing’s ambitious Asian Infrastructure Investment Bank and One Belt, One Road initiatives if reforms lag increasing global exposure.
The problem with the cart being so far ahead is that China is exporting its financial risks to Asia, and beyond, before domestic institutions are ready. A repeat of China’s 2015 stock crash will now have vastly greater ramifications. That’s despite the fact A-shares will be added to the MSCI at only 5% of their market cap weighting. As global pension funds get whipsawed around, broader turbulence is sure to follow.
Two regulatory actions last week—36 hours after the MSCI news—demonstrated why China isn’t ready for prime time. First, China scrutinized its most avid and marquee-caliber overseas acquirers, including Anbang Insurance Group, Dalian Wanda Group, Fosun International Ltd and HNA Group. Sure, it could be part of Beijing’s push to curb risk and corporate debt levels. They could just as easily be in regulators’ cross hairs for political reasons. It also could be a sign Beijing is paranoid about billions of dollars leaving China. Yet the erraticness and opacity of the crackdown slammed share prices and reminded investors of Beijing’s penchant for tripping up markets.
Next, Beijing’s media regulator ordered three major Internet sites to halt video and audio streaming. The terse and sudden edict chopped roughly $1 billion off the market caps of Weibo Corp. and Sina Corp. and left foreign investors running for cover. For all the talk of epochal reform and bowing to “market forces”, China’s media and basic information flows are less open today than in 2012 when President Hu Jintao left office. How does China becoming more of a black box jibe with investors’ bets on a more international and accountable economy?
China playing a larger role in portfolios will cause its own pain from India to South Korea to Taiwan, all of which may see some dilution in market weights. It’s only a good thing, though, if China is up to the challenge. Xi’s record on deemphasizing investment and exports in favour of services is decidedly mixed. So is progress in building a credible banking sector or making companies more transparent. Those figuring all’s grand in Asia’s biggest economy just because MSCI says so might want to hold their horses.
William Pesek, based in Tokyo, is a former columnist for Barron’s and Bloomberg and author of Japanization: What the World Can Learn from Japan’s Lost Decades.
His Twitter handle is @williampesek