China’s painful stock market lesson a golden opportunity to push reform

Beijing has no choice but to allow forces of free enterprise to play a greater role in the economy, but it will be a tough transition

PUBLISHED : Saturday, 09 January, 2016, 12:39am
UPDATED : Saturday, 09 January, 2016, 12:39am

When a market wants to crash, nothing can stop it. China’s regulators are belatedly learning that lesson. After freezing the stock market twice in a week following the introduction of a circuit breaker on the first day of trading in the New Year, the embattled China Securities Regulatory Commission announced it would suspend the mechanism for now. The circuit breaker aimed to calm panic selling, but ended up encouraging it when investors rushed to dump shares before the trigger threshold of market drops of five and seven per cent were reached.

The suspension is no doubt a loss of face for CSRC officials, but at least they had the courage to reverse course quickly. The mechanism needs to be revamped. At the very least, critics have suggested the triggers need to be raised. But the panic selling this week points to problems that run much deeper.

Questions about China’s economic slowdown are driving an outflow of funds from mainland assets. The manufacturing sector has recorded another consecutive contraction, the yuan has plunged to a five-year low against the US dollar and most major fundamental indicators show weakness.

Economists have argued for a long time that there is a disconnect between China’s stock market and the underlying economy. But after so many years of development and reform, there is a greater correlation, which unfortunately now looks bearish. There are questions about whether the 6.5 per cent growth aimed at this year can be achieved.

At the height of the global financial crisis, China was the pivot that helped sustain world economic growth. Today, its slowdown is having the opposite effect on the world economy. Its turbulence spread to other major markets around the world this week. The plunge in the yuan coincides with another fall in major commodity prices as China’s demand for materials weakens.

Chronic overcapacity in heavy industries and overinvestment in fixed assets need to be tackled. This is the time to tough it out and continue to reorient the economy towards one that is based more on the demands of consumers.

The latest crisis is also an opportunity, but one that will test the commitment of China’s leaders to market reform and to allow forces of free enterprise to play a greater role in the economy.

This transition will not be painless, but it is one that the state leaders have no choice but to complete for the sake of the country’s economic future.