Stock rout shows reforms needed to get a market-driven economy

Stock rout shows reforms needed to get a market-driven economy

KIM KYUNG-HOON

SHANGHAI/HONG KONG (Reuters) - The Chinese stock market rout has highlighted the need for further financial reforms and moves toward a market-driven economy, even as Beijing's measures have kept the plunge from turning into a financial crisis.

Policymakers and regulators face the tough task of luring back domestic retail investors battered by the market's tumble as well as foreign investors wary of government intervention.

Investors say reforms, rather than short-term steps such as curtailing IPOs and limiting share sales, are what will nurse markets back to health.

"Some of the longer-term structurally beneficial measures they should take are open up the quota system (QFII), allow pension funds into the equity markets and streamline margin financing rules for both brokers and investors," said Binay Chandgothia, chief investment officer in Hong Kong for Principal Global Investors.

Efforts by Chinese regulators, ministries and local governments to support the stock market do not sit well with foreign investors keen on laissez-faire principles.

"Intervening when the market was still up 80 percent from year-earlier levels made no sense and probably heightened the fears," said Nitin Dialdas, chief investment officer at Mandarin Capital Limited, adding that trading suspensions aggravated matters.

Even after the spill, the Shanghai Composite index is twice year-ago level and still up nearly 20 percent this year.

From China's point of view, it had no choice but to act to stop the bleeding after indexes dropped 30 percent in three weeks starting June 12. The market had virtually frozen with nearly all stocks either staying limit-down or on trading suspension.

Pledging war against a "systematic financial crisis," the People's Bank of China injected hundreds of billions of yuan into brokerages and mutual funds. Major state shareholders were ordered to buy back shares of their listed arms.

This stabilized stock prices, but the heavy intervention was a big reminder that China remains a policy-driven market and Beijing is a long way from reaching its goal of letting the market play the "decisive" role in allocating resources by 2020.

"The government imposes its will on the market from time to time," said an executive in a Chinese brokerage in Shanghai, who declined to be named.

"While it has been talking about letting the market play the key role in the economy by 2020, it appears to still believe it's premature to let the market have the final say."

Dialdas agreed, saying what authorities have done "has resulted in China taking a step backwards in its plans to open up its financial markets".

SAME-DAY TRADING SYSTEM

One change that market players expect Beijing to make is to bring back T+0, or the same-day trading system.

In 1995 China imposed the "T+1" system, which stopped investors selling shares on the same day they bought them. It was done to curb speculation after the main index tripled in two months.

However, regulators kept T+1 in place even after it allowed institutional investors to buy index futures. That trapped retail investors, who dominate the Chinese stock market, in losing positions, while institutions could cover bad bets through futures purchases.

"Looking beyond the recent market-rescuing measures, much needs to be done to improve market mechanisms," said Zhang Yanbing, analyst at Zheshang Securities in Shanghai.

"The resumption of the T+0 system is particularly expected as the market crash betrayed unfairness to retail investors."

Among other problems, traders point to loopholes in China's margin trading regime that allow punters to borrow through unauthorized margin funding organizations.

The irregularity illustrates the problems with a financial system in which rules are only loosely followed when the government wants to expand an equity market to boost corporate fund-raising.

"Reforms will continue but at a varied or slower pace as the authorities deem fit," said Kheng-siang Ng, Asia-Pacific head of fixed income at State Street Global Advisors.

"The country has an aging demographic and there is growing need to reform the financial sector, pension, insurance and health care in order to create an equitable and just society," he said.

(Reporting by Lu Jianxin and Umesh Desai; Editing by Nachum Kaplan and Richard Borsuk)

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