Report from Beijing - 2015 International Finance Forum

The following remarks with subsequent modification were delivered at the November 6-8 convening of the International Finance Forum, headquartered in Beijing. IFF’s mission is to facilitate high-level, multilateral dialogue and promote insights about current issued defining the international economy. The writer is a member of the IFF Academic Committee.

It has been two full years since the convening of the November 2013 Third Plenum of the 18th Chinese Communist Party Congress, when representatives agreed that China would deepen reforms comprehensively and in particular economic system reforms. Across the landscape, pro-reform supporters enthusiastically embraced references to allowing market forces to play a “decisive” role. This, they said, would be central to China’s future economic growth.

The excitement among participants at that year’s IFF meeting less than a month following the Plenum, was equally palpable. There would be government-led and organized institutional support to ensure that reforms would be pursued with commitment. There was an underscoring of commitment and intimations of a blueprint or plan.

Chaired by the late Cheng Siwei, our highly respected founder and economic statesman, that year’s IFF forum contemplated what the reform blueprint would mean for China’s economic grown and the advancement of the country’s growing middle class. It was exciting and hopeful.

But something happened between then and now to raise the question as to whether the reform calculus could be undergoing modification. What happened is that the global economy failed to respond as quickly as hoped to policy efforts to resolve the serious aftermath of the global financial crisis.

The Federal Reserve undertook unprecedented easing measures and is only now, seven years’ hence, considering unwinding the outsized accommodation.  Europe’s economies waded through one economic quagmire after another. The market for commodities and oil deteriorated. Oil and gas discoveries in the United States added to growing supplies at the same time that demand waned in step with China’s economic slowdown. Importantly, there were unmistakable signs that China’s double-digit, wildfire growth had come to an end.

China’s slowdown took on a name of its own – the “new normal”, intended to signify an emphasis in the Chinese economy on quality growth versus quantity. Pursued in tandem with an impressively-articulated emphasis on innovation and technology, the new normal became the pivotal point in a dramatic, long-term plan to transition from being the world’s largest manufacturing floor to a more sustainable, consumer- and services-driven economy with capacity to ease the world’s largest population out of an approaching middle income trap.

Then something else happened. Volatility exploded this past summer in China’s capital markets. Multiple sources fed the explosion, which for a time, pushed well beyond the control of regulators and authorities. Consequent interventions, both formal and informal, cooled fears, which at their worst viewed the interventions as a rollback in liberalization to date; and at their best, suggested only a temporary dampening of reform commitments.  

Wherever we are today on that continuum between pessimism and optimism, a gnawing concern still hovers that the once vibrant discussion about financial and capital market reform – so vital to a market-driven economy – has been displaced by more audible calls for GDP growth and economic development. These interests are notably being translated by way of an official call to arms to double GDP and household income by 2020.

Perhaps any number of details are missing in this analysis. However, there is a sense that a once vibrant discussion about a lesser role for government and a more “decisive” role for market forces is being downplayed and even muted in some quarters.

Yes, IPO registration procedures are back on, and the effort appear to be taking hold. Early and deeply appreciated steps toward liberalizing interest rates, starting with deposit insurance, are happening. Market forces are given some small say in the daily spot rate-setting of the RMB. The currency’s exposure while still slight, continues to grow regionally as well as globally as the number of central banks adding yuan to their reserves expands.

Too, there is excitement about the prospective inclusion of the RMB in the IMF”s Special Drawing Rights basket of currencies. A decision by the IMF board is expected in late November. China’s reformers have fought long and hard for this recognition of their currency, still tradeable only in specific circumstances and even though any victory will be largely symbolic given IMF’s set up. 

So what’s missing, and why is it important? Perhaps compelling data points are still missing but it seems that absent from today’s dialogue is the commitment that was once on the tip of tongues in late 2013 when reforms were talked about in terms of transparency and market forces as the unequivocal underpinnings of successful markets with capacity to fairly set prices for buyers and sellers.

Part and parcel with the hallmarks of transparency and market forces is the dedication to ensuring a sound, open structure for data management; regulators with strong risk management skills and the leeway to utilize those skills; a pipeline for talent particularly at the administrative levels; and the opportunity for open communication regulator to regulator, regulator to government, and the market to the individual investor.

That’s what makes markets work. It’s the so-called “invisible hand” of markets that works best for the benefit of all, and it should be able to clap independent of the hand of officialdom.

There is always good value in reviewing what has happened, and in this instance in reviewing what happened with China’s markets earlier this year. There is value in making assessments and then figuring out what might be done differently going forward so as not to repeat mistakes and to improve systems. No system is ever perfect. All systems require ongoing checks and reviews.

And in this instance, such reviews can help shore up lost credibility as a result of earlier interventions.

South Korea’s former Prime Minister, Han Seung-soo, remarked earlier in this IFF forum that the events in question contributed to “divergent views” about the global implications of a hard versus soft landing of China’s domestic economy. Either way, it was crystal clear that China’s economy now stood at the epicenter of the global economy.

This divergence in viewpoints underscored the need for markets to have and exercise their capacity for responsibly providing accurate and timely communications to both domestic and international parties. Instead, the experience earlier this year was mostly opaque. Not even regulators, it seems, could pull back the veil on the market environment. What’s more the opaqueness served to compound problems associated with volatility. Reining it in became a slippery slope.

Information, communication and transparency are all critical to markets working efficiently and in a wider sense, to credibility that keeps investors coming back for more.

A group of Chinese and US government officials, regulators, practitioners and academics who participated in last September’s US/China Dialogue on Financial Systems shared this line of thought.  The annual Dialogue was convened by Harvard University Program on International Financial Systems (PIFS) together with PIFS’ partner, the China Development Research Foundation (CDRF).

As might be expected, a key dialogue topic was: Capital Markets: Access and Volatility. Participants agreed – and this is part of a published report, that the quality of regulation governing China’s capital markets, the expertise of regulators and administrative officers, and constraints on the system due to a lack of transparency, combined neatly to bring the market to its knees.

Inadequate transparency contributed to administrators’ incapacity to use appropriate mechanisms to rein in volatility that was enveloping the market. Intervention, both formal and informal, was the consequence. Interventions per se are not unprecedented in developed markets. At the same time, the severity of the intervention prompted those at the Dialogue to ask: Were authorities also unwinding hard-earned liberalization measures?

We asked what could happen the next time when the bar might be lower.  Where was the credibility? Authorities’ actions were unpredictable at best, so was it now clear that there was and is no reform blueprint?

We discussed the formal as well as “informal” interventions, specifically taking note of actions such as the instructions to broker dealers to get on the team and buy stocks to shore up prices; investigations into market participants, both domestic and foreign, and the arrest of a reporter with a solid track record working for a respected business news publication for the “mistake” of reporting on the government’s response to market declines.

Consensus of the Harvard/CDRF symposium was two-fold: We advocated reforms that would enlarge the market’s capacity for openness, information and transparency. We agreed that the experience had been difficult, but it should not become a catchall excuse for slowing or suspending the reform agenda.

At the end of the day, it may be wrong-headed to think that the reform agenda is being overshadowed or even worse, hijacked by interests that favor an emphasis on GDP growth. Perhaps, instead of being waylaid, current circumstances point to a time-out until the pieces can be put back together. Perhaps, we are seeing a temporary phenomenon until the right moment is again at hand.

Aristotle, that ancient western philosopher, is said to have remarked: One swallow does not make the spring. So perhaps the events earlier this year are like that single swallow, and we are in fact poised for a full-blown transparent spring in China’s markets.