Sunday, October 18, 2009

Shanghai as an international finance center?

The Banker: Shanghai steams in; Shift in the balance
China Daily: China boosts int'l use of renminbi with bond sale in HK
WSJ: China Expands Yuan Bonds

China aims to establish its own international financial center (“IFC”) in Shanghai by 2020. Will Shanghai fulfill that ambition? The leading IFCs in Western markets are taking China’s plan very seriously. Stuart Fraser of City of London Corporation says that the biggest threat comes from “the places whether the most money will be made and where the huge growth rates are.” Indeed, China’s financial markets have shown impressive growth. The Shanghai Stock Exchange is the world’s third largest stock exchange in terms of market capitalization. China’s capital raising capacity and debt markets are expanding at an exceptional rate.

Recent developments are also encouraging, indicating China’s willingness to open its financial markets. China has been trying to internationalize its currency, the renminbi, and make it convertible. Since December 2008, the State Council has established pilot schemes to enable five cities in China including Shanghai to settle trade payments in renminbi with Association of South-east Nations members. In September this year, China started to sell Rmb6bn (US$879 m) of government bonds to offshore investors for the first time. Also, in January 2009, China allowed foreign banks to trade and underwrite corporate bonds in the interbank market.

However, according to The Banker, there are significant barriers to overcome. First, China will not achieve its ambition unless it establishes “the rule of law, including an independent judiciary and government transparency,” says Andy Rothman, China’s strategist at CLSA-Asia-Pacific Markets. China’s legal and regulatory framework is “opaque and unpredictable” and company and securities law still lags behind the law in other IFCs. Also, laws tend to favor domestic firms over foreign firms and provide little protection to foreign investors (e.g., the 2007 insolvency law). Second, China needs to float the renminbi freely since an IFC would not be possible with a fixed exchange rate system. It is not clear whether China would be willing to take this step by 2020. As long as the government tries to support its export-oriented economic growth and facilitate domestic consumption, a rising renmimbi may not be a risk worth taking.

The Banker further points out that there would be more fundamental challenges to China’s goal as the communist government continues to adhere to its government-controlled capitalism. There is no market discipline and the government changes market norms as it deems fit. Also, the government is heavily involved in the allocation and pricing of financial resources. Accordingly, Shanghai lacks vibrant small and medium-sized enterprises and a competitive service sector, which are crucial for developing a successful financial market. Bad quality real estate, poorly planned infrastructure and overcapacity in industrial sectors are also the consequences of a misallocation of resources.

Discussion Questions:
1. What are the things that make China (or Shanghai) more attractive or less attractive to investors than other IFCs?
2. According to Mr. Rothman of CLSA, China has been moving quickly toward a market economy over the past one or two decades, yet is trying not to make the transition too quickly. He further explains that the Chinese are “careful students”; China learned lessons from history and from other countries and is "determined not to make the same mistakes." Do you agree with his view?
3. How long do you think China’s government-controlled capitalism would work? Would it ultimately require changes in the Chinese political system?

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