The Big Bull vs the Silent Dragon

The bronze sculpture of the charging bull that stands on Broadway is perhaps the most well-known totem representing the spirit of the New York Stock Exchange that evolved from a meeting of 24 stockbrokers under a buttonwood tree in 1792 on what is now Wall Street. In contrast, though founded in 1891 and re-established in November 1990, the Shanghai stock exchange is an upstart and is not associated with any specific monument.   Had it been, the amulet of a silent dragon could perhaps have been an appropriate one. Has this newcomer, the fictional silent dragon, started questioning the hegemony of the big old bull? Or, more broadly and fundamentally, has China, the second-largest economy on earth (in terms of gross domestic product, or GDP, at market exchange rate), started having a significant financial centre?

Some numbers may tell a part of the story. In October 2020, Shanghai overtook Tokyo as the third-ranked financial centre, after New York and London, according to the latest Global Financial Centres Index, published jointly by the Z/Yen Group, a leading commercial think-tank based in London, and the China Development Institute, a think tank in Shenzhen. Pursuant to liberalisation measures undertaken in-connection with the Shanghai-Hong Kong Stock Connect, Shanghai-London Stock Connect, Bond Connect, and Shanghai Gold Exchange and the inclusion of China-A shares in international indices such as MSCI, FTSE and S&P, Shanghai has become the go-to destination for international investors who have an appetite for RMB-denominated asset allocation. These rankings serve as a testament to the fact that Chinese capital markets are gradually getting deeply integrated with global markets.

But how did it happen? Despite China’s emergence as a hub of the global supply chain, till very recently, China was seen as a laggard in terms of financial activities. China was seen as a currency manipulator with a considerable number of restrictions on foreign investment. The Chinese yuan continues to remain non-convertible to a large extent. While the size of the US financial sector is estimated to be roughly one-fifth of its GDP, the share of the Chinese financial sector would, in all likelihood, not exceed 10 per cent of Chinese GDP. Besides, Chinese banks are seen as huge burdens on the state exchequer with all their legacy of stressed assets. Finally, Hong Kong was already there as a global financial centre. Thus, in popular perception, China is an unlikely candidate where the financial sector would emerge with dynamism.

The emergence of the Shanghai stock market has been an outcome of conscious policy measures that have been overlooked in the stereotypical stories. Notable measures undertaken by the Chinese authorities include revamping the benchmark of Shanghai Stock Exchange (SSE), removing price caps for Shenzhen's ChiNext board, examining the plausibility of same-day (T+0) settlement in SSE, making matters easy for firms intent on issuing exchange-traded debt, permitting the trading of bond futures and stock options, setting-up of Over-the-Counter (OTC) market, easing pathways for a follow-on public offers at more significant discounts, opening up the capital markets to global investment banks, and putting in place a market-led system for loan origination and pricing.

Further, The People's Bank of China has expressed an intention to adopt the Depositary-Institutions Repo (DR) rate as the benchmark for lending. Future calibration and development of DR with encouragement for issuances of floating-rate debts and interest rate swaps referenced to DR, DR-based inter-bank transactions, the establishment of DR-based yield curve, and adoption of DR for calculating interest rate for RMB are on the offing.

Notwithstanding the allegations against China in connection with the origins of the covid-19, the veracity of official covid-19 fatality numbers and the efficacy of Chinese-made vaccines, the Chinese economy is the only large economy that has registered positive growth of 2.3 per cent during 2020. More recently, it has exhibited a sharp recovery with a GDP growth of 18.3 per cent in the first quarter of 2021. Besides, on account of the silent regulatory reforms undertaken by the Chinese authorities since 2018, China has bounced back into the radar of the Global Financial Institutions that are expanding their foothold in mainland China.

The Global Financial Crisis during 2008-2009 served as a clarion call for necessary checks and balances to address the potential fallibility of uncontrolled and interconnected financial markets. Despite the apprehension of the proponents of “light touch regulation” that the world would respond with regulatory overreach, regulatory arbitrage in the run-up to the global financial crisis and consequent regulatory overreach did happen. In such an atmosphere of regulatory activism, Chinese efforts towards attracting the attention of global investors seemed to have borne fruit.  It remains to be seen whether the bipolarity of economic power, in terms of shares in real economies between the US and China, gets extended to financial spheres. While that could become yet another feather in the Chinese cap, it has serious implications for global finance.

Ray is a former professor of the Indian Institute of Management Calcutta, and Madhavan is an associate professor at Ahmedabad University