×

Three things China needs to do right now

More money for interventions and less will power for reform is not the long-term solution to China's ongoing stock market woes.

After a roller-coaster ride of a week that saw Chinese stocks lose trillions in value, Beijing's aggressive interventions in its plummeting equity markets have halted the slide for now.



An investor reacts inside a brokerage firm on July 8, 2015 in Shanghai, China.
On Man Kevin Lee | Getty Images
An investor reacts inside a brokerage firm on July 8, 2015 in Shanghai, China.

As of Tuesday's close, the benchmark Shanghai Composite Index was up 12 percent for the week, though it's still down 24.2 percent from its June high and large numbers of listed companies are still suspended from trading on the nation's Shanghai and Shenzhen exchanges.

Direct and indirect government involvement to help shore up stock prices and placate the Chinese small-scale shareholders who dominate the marketplace has included warnings to short-sellers, the suspension of new IPOs, support for brokerages and the establishment of a market-stabilization fund to help inject funds into the market.

So, what next for China's financial mandarins? Even in a "command economy" with trillions of dollars in reserves, it would be a mistake for them to think China's ability to "command" domestic behavior can replace the fundamental need for changes and continued reform.

Here are three steps that Beijing should commit to if markets are to more sustainably resume their upward climb.

Beijing must re-commit to the opening of its financial markets and to a deepening of capital market reforms. Rules preventing foreigners from directly investing in A shares traded on the Shanghai and Shenzhen exchanges combined with limited investment opportunities for Chinese citizens have led to markets being dominated by small-time shareholders, including many less sophisticated Chinese investors trading on margin. This has significantly contributed to market fluctuations and the present crisis.

Read More China is not yet a buy

Last year, China's State Council announced it would move forward on a number of financial reforms. These included making progress toward direct bond issuances by local governments, removing some of the limits on using financial derivatives, and streamlining the approval process for IPOs as well as increasing quotas for both inward and outward foreign investment.

Some progress has been made with innovations including the introduction last November of Shanghai-Hong Kong Stock Connect. While subject to quotas, this link between the Shanghai Stock Exchange and the Hong Kong Stock Exchange has increased two-way market access by eligible mainland and Hong Kong Chinese investors. This should be built on.

China must allow more of its corporations to succeed on their own (by limiting government interventions) and to fail. With every market intervention, investors may be left wondering whether any investment will ultimately pay off based on its merits.

While the recent focus has been understandably on the nation's equity markets, China's credit markets also need to be allowed to mature – onshore and offshore. This will include permitting Chinese companies, including state-owned enterprises, to default on corporate bond payments.

Read More Why China stock market will bounce back

Since March 2014, a handful of companies have been allowed to default on payments. Bondholders may not be happy with losses, but such defaults should be welcomed as a sign of China's further financial maturation. This too must continue.

China would do well by announcing that it is phasing out its borrowing from both the World Bank and Asian Development Bank – international financial institutions that provide concessional loans and grants to finance infrastructure and other projects in the poorest nations. Instead, China should concentrate on the broader economic reforms advocated by these multilateral organizations.

This will include continuing to take steps to build an enabling environment for the private sector – one marked by strengthened rule of law, greater transparency and accountability, and best practices in corporate governance. Such a commitment would in the long run be to the benefit of all of China's listed companies.

The ability of China to pledge tens of billions of dollars in seed capital to new financial institutions – including a new China-led Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB) launched by Brazil, Russia, India, China and South Africa – and a program of new "Silk Road" and "maritime Silk Road" infrastructure investments around the Asia-Pacific region underscores the nation's ability to find the funds for initiatives important to its national interests.

Read More What's next for China's 'World Bank'?

What is important for China's leaders – and investors, both foreign and domestic – to keep in mind now will be the answer to a fundamental question: Out of this crisis, has Beijing grasped the opportunity to make the changes that are necessary to fostering long-term trust and confidence by investors? China certainly has the power and more than enough resources to intervene in its own markets. More important, however, will be the will power to refrain from doing so in favor of the fundamental changes and continued reform that will help ensure long-term, sustainable growth.

Commentary by Curtis S. Chin, a former U.S. Ambassador to the Asian Development Bank. He is currently managing director of advisory firm RiverPeak Group. Follow him on Twitter at @CurtisSChin.