Unlocking Value – Exploring The Shanghai Global Exchange Idea

The latest economic data out of China clearly suggests that the overall economic growth rate has most likely peaked, and the economy is now going through a transition period, in other words, a shift in gear. And this transition period needs to be managed well through policy changes and other measures. The policy makers will need to be proactive, and it is probably one of the reasons why the central bank of the country ( PBOC ) decided to extend RMB 100 bn worth of liquidity to the largest banks in China. But any monetary policy tool has its limitations, and the transition will require the leadership to push through essential reforms and adjustment in the economy.

Going forward, the pressure on the leadership and the policymakers to take additional measures to shore up growth will remain somewhat high especially considering the growth target level set by the leadership, but it will be important for the decision makers in China to look at the bigger picture while having a long term perspective in mind. Also considering the overall macro picture, it is quite likely that China based companies may find overseas markets a bit more attractive so it is quite plausible that China’s overall overseas investment might exceed the incoming FDI in the country going forward.

The construction and property sector of the economy has made significant contribution to China’s overall growth rate over a considerable period of time, but there are clear and visible signs that the sector is now entering an oversupply phase. And in the long run, new stimulus measure for the sector may in fact do more harm than good to the overall economy. So the focus should be on consolidation, and managing transition period well while working on unlocking value from other sectors of the economy.

So it is important for Beijing to look at ways to facilitate sustainable growth by exploiting potential value from other sectors of the economy as a way of diversification. And with the creation of BRICS development bank that is to be based in Shanghai, the city and the leadership in China should take the opportunity to lay down the foundation of a future global financial centre, and also start the process of unlocking  value from the financial sector.

The new financial centre should not be modelled or based on any of the existing global financial centres, and the aim should be to look ahead in the future, by creating a financial services infrastructure that can stand the test of time, with open access, and created for the world while creating jobs and growth for the Chinese economy. Also through the financial centre, the policy makers in China could explore ways to better utilise a substantially large shadow banking system with an estimated worth of over US 6 trillion.

And by having the new BRICS development bank based in the proposed financial centre, the government could kick start the process. This is why the bank should not be modelled as a rival to IMF or World Bank, because then it runs the risk of becoming another multilateral agency too slow to change the way the global economy works, but instead, it should aim to take the world and Chinese economy to the next level. The BRICS bank based in the new global financial centre could  plug right into the existing financial infrastructure of the central banks of BRICS nations,and create an integrated platform to facilitate local currency trade settlements among the members, and also develop the ability to finance projects in local currency of the member countries. The other counter parties including of the players from the shadows banking system could also plug into the proposed global financial centre, and make good of various new opportunities by deploying  their capital better.

Most emerging market economies require a buffering or protection against currency exchange risks in the time of extreme volatility, and going forward, the players in the financial centre along with the BRICS development bank could play an important and significant role  in absorbing some of these risks by facilitating trade settlements in local currencies or non physical  trading currency Unit that can be converted into local currency of the vendors. All this could be facilitated by the financial centre with support from BRICS development bank acting as a facilitator, and as an independent counter-party connected to the central banks of the BRICS nations as well as other emerging economies. The conversion and exchange mechanism of the non physical trading currency unit into local currency could be worked out easily between the central banks and the BRICS development bank, and offered to regular clients by intermediaries based in the proposed financial centre. So the volume of overall transactions done through the financial centre could easily reach over trillion dollars mark making the centre an important financial HUB.

And the Government could position Shanghai as the natural financial hub / centre for global emerging economies, where the emerging economies and the companies based in the EM could come to trade and also raise money. And this could help create a first Global Exchange focused on emerging markets. An exchange that will facilitate trading of loans,debts, equities, commodities, funds among other things. The local companies based in China will also benefit immensely from the pool of liquidity provided by the exchange, and by their exposure to the world without having to leave their own backyard. And as suggested before, the existing shadow banking system in China could also play an important role in the whole scheme of things.

The importance of diversification cannot be understated, it is worth noting that although the overall growth rate of the Chinese economy has most likely peaked, still by most projections, the Chinese economy is projected to become larger than the US economy by the year 2020, but its per capita income is estimated to be less than US$ 17,000. Also, the cost of manufacturing is estimated to rise by over 105% making the economy less competitive, so quite clearly the economy is entering a transition period. This is why the policy makers and the leadership of the country will need to work hard on navigating the road ahead by exploring all the under utilised economic potentials of the country. So creating a global financial HUB should fit quite well in the overall plan, and is an idea worth exploring.

There are also significant geopolitical benefits of having the world come to you, and trade with you, also in most likelihood the leadership in China should be able to use this as a soft power approach to promote China. But for this to work, the market participants will have to feel confident and comfortable with the regulations, the governance structure, and the overall jurisdiction related issues among other things. So the government of the day will have to be willing to create a special legislative framework that will allow the financial centre to run at arm’s length from Beijing. This could be a challenging task, but the opportunity is huge. And there is already an existing precedent. After the creation of Shanghai Free trade Zone, some Asian banks including of Singapore based banks have seen their yuan based business grow significantly in size.

The approach will have to be collaborative, and not solely aimed at competing with existing financial centres of the world including of London or New York. Also by design, the new global financial centre should be able to serve and support other major financial centres of the world as an additional and important engine keeping the world economy flying.