China’s financial market reforms

China’s financial market reforms

Good morning and welcome to today’s foreign exchange market commentary on Wednesday, the 6th of February.

The Chinese economy has posted strong gains in nearly all parameters in the fourth quarter of 2012, signalling a return to growth across all sectors. But, while the country’s overall recovery lifted consumer sentiments, stock market performance has been surprisingly weak for the world’s second largest economy.

The Shanghai Stock Exchange added a paltry 3.17 percent in 2012, puzzling investors and economists alike. If the economy is bouncing back, why are the equity markets responding slowly, and at times negatively, to signs of recovery?

The Shanghai Stock Exchange ranks seventh in terms of market capitalisation, and at $2.2 trillion, it is one-sixth of the NYSE. The Tokyo Stock Exchange is 1.6 times bigger than Shanghai and the SSE’s market capitalisation resembles that of the Toronto Stock Exchange. But Canada has a population of $35 million and has witnessed an average growth of 0.8 percent over the past half-century while China has a population of 1.3 billion and has grown at around 10 percent in the last three decades.

The answer is simple. Beijing must allow full convertibility of the renminbi and allow the currency to float freely, and then the SSE will begin to reflect China’s economic might more accurately.

To be sure, the SSE has a history of volatility. Securities market trading started by 1860 in Shanghai, making it the Far East’s leading financial hub by 1930. But following Japan’s invasion in 1941, trading was halted abruptly. The SSE resumed operations in 1990 following Deng Xiaoping’s program of economic reforms.

Disconnect between the economy and equities came to the fore in 2001, when China joined the World Trade Organisation. As exports soared, prosperity followed and fuelled rapid GDP growth. But market value halved following a four-year slump in equities.

The government responded by banning new IPOs in 2005 and the constraint pushed equity participation higher. But when the ban was lifted a year later, speculators rushed in; after reaching a high of 6,100 points by the end of 2007 – when global economic crises broke out, the index plunged an unprecedented 65 percent by the end of 2008.

But change is in the air. Authorities initiated financial reforms last year to widen the country’s equity, currency and bond markets. Smaller firms now find it easy to sell bonds via Shanghai and Shenzhen stock exchanges while authorities tighten rules to address investor concerns. Delisting norms have been made stricter while supervision of companies suspected of insider trading has been tightened.

But China has a long way to go before its financial system becomes capable of processing the country’s domestic savings. The people of China should reap the benefits of the country’s economic success rather than continuing to export capital to foreign shores.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.1545
GBP/US$ – 1.5649
GBP/CHF – 1.4821
GBP/CAN$ – 1.5594
GBP/AUS$ – 1.5155
GBP/ZAR – 13.8435
GBP/JPY – 146.78
GBP/HKD – 12.1310
GBP/NZD – 1.8559
GBP/SEK – 9.9226

EUR: The single currency performed well against majority of currencies yesterday, finding support in European data. Services PMI reading across the region (barring Italy) came in better than expected. Sterling got an early boost on UK services PMI release, but the gains proved short-lived as concerns that incoming BoE governor will initiate further quantitative easing to stimulate growth pushed traders to the sidelines. Euro staged a recovery soon and the GBP/EUR pair dipped below 1.160 while the EUR/USD pair rallied to 1.36. French President Francois Hollande warned against a rising euro and called for an exchange rate policy for the shared currency, but the German Economy Minister countered his claim saying focus should be on the economy’s strength and not the currency’s weakness. Markets seem to believe that the ECB is unlikely to intervene to weaken the euro amid conflicting views from the region’s policymakers. We have the German factory orders data due today while UK house price data came in on forecast at -0.2 percent early in the morning. The GBP/EUR pair is trading at around 1.1589 now.

USD: The US dollar had a fairly mixed day yesterday, gaining against the pound and the Japanese Yen, trading consistently above 93 yen for the first time since spring 2010 and the hitting the highest against sterling since August 2012. Rising risk appetite, fuelled by a better-than-expected US services sector PMI helped the greenback further during the US session. Volatility levels for sterling are high, suggesting further downside moves against the US unit are possible though there is a dearth of data releases today and markets seem to have positioned themselves for key central bank meetings tomorrow. The GBP/USD pair is trading around the 1.5650 level currently.

Have a great day!

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