Wait before you applaud the CSRC’s climbdown

The decision to scrap the index circuit breaker looks to be a return to pragmatism, but more is needed to convince investors of the “decisiveness” of market forces.
Wait before you applaud the CSRC’s climbdown

The China Securities and Regulatory Commission’s index circuit-breaker lasted four days. On Thursday night, chairman Xiao Gang threw in the towel and abolished the measure.

Is this a reflection of pragmatism or ideology? Is this the leadership accepting that it cannot control markets or a tactical retreat in preparation of a new assault to retake finance’s commanding heights?

China’s reform process, stretching back to the Deng Xiaoping days, has been guided by pragmatism. This has served China well. Markets and businesspeople perceived Beijing policymaking as the practical application of ideas, based on an acceptance of the world as it is – until last summer, when a foolish, state-engineered equities bubble burst.

Under President Xi Jinping, economic reform (letting markets play the 'decisive role') has been twinned with the re-assertion of the monopolisation of political power. These goals are contradictory, as has been demonstrated by the government’s fumbling over the stock market.

The latest attempt to temper market panic in A shares came at the start of this week, when the CSRC implemented a circuit-breaker on the benchmark CSI300 index. Any move by the index of 5% in either direction would trigger a 15-minute trading halt for all listed instruments; a 7% swing would close the market for the rest of the day.

The CSRC ate its hat four days later when, on Thursday night (January 7), it admitted its market circuit breakers had proven to be counterproductive and scrapped them.

The hopeful explanation is that the CSRC has returned to pragmatism: it recognised the policy had worsened volatility instead of calming it, and chairman Xiao Gang reversed the rule before things got even worse.

This acceptance of reality is rare among policymakers in other countries. Saving face often trumps facing evidence.

For example, on January 5, the US Financial Accounting Standards Board (FASB) finally rescinded a 2007 accounting rule around how banks presented their results. The rule, addressing a technicality called debt-valuation adjustments, had led to nonsensical swings in bank valuations. Like the Chinese circuit-breaker, it was a well-intended rule introduced at a time of crisis. But whereas it has taken nine years for the FASB to grudgingly withdraw the measure, it has taken CSRC just one week of market turmoil to act.

One difference, of course, is that the market forces storming China’s bourses are far stronger than analyst and bank CEO complaints in post-crisis New York. Seeing your market shut down twice in one week, with Thursday’s trading lasting a mere 14 minutes – making it the laughing stock of the international financial community – has a way of focusing the mind.

(China’s circuit-breaker was also superior to those found elsewhere, in that it included halts when the market rose too fast. In the US, market curbs only exist to calm bear markets and therefore are biased towards supporting bubbles.)

If this is a return to pragmatism, it suggests that the leadership in Beijing is accepting the reality of how markets operate. By this reading, price discovery will be allowed and investors, not government fiat, will guide the market to its natural level, thus allowing companies to properly price their assets.

Moreover, the turmoil was caused by an unfortunate but coincidental depreciation of the renminbi, which itself has been moved to a more market-responsive footing. The pro-pragmatism reading suggests the move by the People’s Bank of China to broaden the renminbi’s currency basket, on the back of its recently acquired special drawing rights status, is part of a long-term plan to broaden capital flows.

But the reason Xiao gave for ending the index circuit-breaker suggests that ideology still dominates the thinking among policymakers. His language was all about better methods of squashing volatility, rather than hailing the “decisive markets” once promised by the leadership. The CSRC’s climbdown has not been matched by a willingness to decriminalise share sales or other steps to allow the valuation overhang to correct.

This interpretation suggests the Party is still determined that it should determine the true price of assets.

China can live with a dysfunctional stock market, but it can’t continue without the big-picture economic reforms taking place. It can’t go on without a huge transfer of wealth from the state sector to households, without risking a credit bust of epic proportions.

So is scrapping the circuit-breaker a case of Deng-inspired pragmatism or Xi-driven ideology? Further steps will reveal whether this is the start of a more realistic approach to financial markets – or a continuing, and disappointing, inability of Xi’s China to reconcile itself to market forces.

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