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The most important thing to consider about the epic Chinese stock rout that began 12 months ago is that it’s not over.

For one thing, the Shanghai Composite Index remains too high even after a 40% correction. Every other major market is three times cheaper than domestic A shares. In fact, at roughly 60, China’s median price-to-earnings ratio is more irrationally exuberant than U.S. tech stocks were at the top tick in 2000. For another, shares are at last tracking Beijing’s slowing economy, and that means more downside.

But Shanghai’s real problem is that little is afoot in Beijing to stabilize the fundamentals that underpin markets. And that’s why the decision makers at MSCI should resist the urge to embrace China’s stock market.

Sure, the market has a powerful backstop in President Xi Jinping. His government has tossed hundreds of billions of dollars and policy Band Aids at cascading equities: hoarding shares; halting initial public offerings; loosening leveraging and borrowing rules; switching off huge swaths of the market. What Xi’s men haven’t done is restore confidence in Shanghai’s $6 trillion market by recalibrating growth engines, increasing transparency, tightening corporate governance and learning to communicate with investors.

MSCI is being lobbied pretty hard to include China later this month. China wants in really bad, viewing it as the next logical step after entering the International Monetary Fund’s special-drawing-rights program last year and the World Trade Organization 15 years earlier. So do China bulls looking to ride a tidal wave of cash zooming into mainland names like Alibaba. Inclusion now, though, would communicate the wrong message to officials in Beijing failing the most basic of tests, including communication.

This failure is foremost on Jacob Lew’s mind this week as the U.S. Treasury secretary meets with Chinese officials in Beijing. South China Sea tensions are the first point of order with Lew and Secretary of State John Kerry in town for the annual U.S.-China Strategic and Economic Dialogue. But Lew hit the weekend news-show circuit to call on Beijing to hone its market-communication skills as its economy plays an increasingly dominant role in world affairs. In doing so, Lew is highlighting one of Shanghai’s main, but still underappreciated vulnerabilities.

Stock crashes happen, of course, as Wall Street reminded the world in 2008. But, as Lew points out, the fallout from the August currency devaluation that shook world markets - and myriad conflicting polity signals since - continues to undermine trust in the No. 2 economy. Lew is recounting how he was on holiday on Aug. 10, 2015, when the People’s Bank of China weakened the yuan. He spent the rest of his vacation on conference calls urging Beijing to explain the rationale behind the move to panicky markets.

While that prompted PBOC Governor Zhou Xiaochuan to hit the speaking circuit, too, the fallout has yet to dissipate. Try as they may, neither Xi nor Zhou has allayed fears that China’s economy is in a much weaker state than official data suggest. That’s as good a reason as any for MSCI to defer China’s bid. Will it? As my Barron’s Asia colleague Shuli Ren reported last week, Goldman Sachs assigns 70% odds to inclusion, while Citigroup puts them at about 51%. Credit Suisse, meanwhile, puts odds of rejection at 60%.

Increasingly, says University of Tokyo economist Masahiro Kawai, Beijing’s spotty communication is a metaphor for its inability to shoot straight. If China were doing more to fix its underlying finances, it would be less reticent about sharing its plans and progress. Inadvertently, Kawai says, “it sends the message that a rapid credit expansion and mounting corporate debt could lead to a banking crisis, and that the progress on state-owned-enterprise reform is slow.”

“ Much of the buying in Shanghai these days is with borrowed money, leaving market unstable and vulnerable to big swings. The index giant should hold Beijing’s feet to the fire, incentivizing officials to strengthen market mechanisms, internationalize the regulatory structure and prod corporate boards to embrace global best-practices norms. ”

This perception problem came up often at a panel discussion I moderated in Tokyo the other day. There, Alfred Schipke, a senior IMF representative in Beijing, voiced concern that China’s 6.5% growth target is too high and warping incentives to recalibrate the economy. Yosuke Tsuyuguchi, a senior advisory officer of Shinkin Central Bank questioned whether financial institutions are acting fast enough to avoid a Japan-like bad-loan crisis. Bottom line, says Patrick Chovanec of Silvercrest Asset Management, “a whole lot of new investors coming in” doesn’t improve fundamentals -- it just distracts us from them. Pyramid scheme, anyone?

MSCI risks rewarding Beijing’s bad behavior at the worst possible moment. Much of the buying in Shanghai these days is with borrowed money, leaving market unstable and vulnerable to big swings. The index giant should hold Beijing’s feet to the fire, incentivizing officials to strengthen market mechanisms, internationalize the regulatory structure and prod corporate boards to embrace global best-practices norms. That’s what MSCI did in June 2015 when it said no, and presciently so. It would’ve left overseas fund managers far more exposed to Shanghai’s plunge in the weeks that followed.

Regulators have indeed tweaked Shanghai’s market infrastructure, providing greater clarity in mergers-and-acquisitions deals and the mechanics of foreign ownership. But thorny issues remain, including the logistics of foreigners navigating quotas and licenses (getting money out as easily as getting it in) and lifting the opacity that reigns in China’s financial sector. MSCI also should encourage Beijing to allow greater media freedom to reduce corruption and help police corporate malfeasance.

The question, of course, is how these and other reforms are implemented. By adding Chinese A-shares now, MSCI would give Beijing the benefit of the doubt. That proved to be a mistake in 2001, when the West assumed WTO inclusion would level the playing field. In reality, it lowered the West’s defenses and allowed Beijing to have its way with the global trading system. The same may be true of welcoming China into the IMF’s reserve-currency club. China has yet to respond with the transparency and yuan-strengthening many expected.

This should give investors excited about Beijing expanding its link between stock bourses in Hong Kong and Shanghai to Shenzhen pause for thought. It may increase the outside world’s access to China, but does zero to alter the complacency in Beijing destroying trillions of dollars of wealth in Shanghai.

Comments? E-mail us at william.pesek@barrons.com

Comments? E-mail us at asia.editors@barrons.com