First it was the biggest stock market boom in history. Then it turned into one of the biggest bear markets. And now it is raising questions about the financial grip of the regime that rules what is, by some measures, the world’s biggest economy.
The story of the Chinese stock market over the past year is well rehearsed. After years of treading water, the valuations of companies listed on the two major Chinese exchanges – Shanghai and Shenzhen – suddenly exploded in June 2014, probably because an army of leveraged small local investors flooded into the market at around that same time.
Shanghai ballooned 150 per cent over 12 months. Shenzhen shot up almost 200 per cent in the same period. And then came an almighty bust, which some have dubbed “The Great Fall of China”. Since 12 June Shanghai is down 30 per cent. Shenzhen is 40 per cent lower. That has wiped $3 trillion off paper values, roughly equivalent to the entire market capitalisation of the FTSE100. And both indexes are still falling.
The response of the Beijing authorities has swung from insouciance to concern, to exhortation, to something that looks increasingly like lever-pulling desperation.
Yet all Beijing’s attempts to stem the bleeding have failed. The central bank cut interest rates, to no avail. The state media was deployed to talk up shares. IPOs have been cancelled to reduce the supply of new equity. Brokers and mutual funds have been corralled into propping up the market. But despite a few sharp upticks the relentless downward trend of prices has continued. “There is a panic but no matter how they jump in, this thing just doesn’t stop falling,” Dong Tao at Credit Suisse in Hong Kong said.
From the outside its looks like a classic stock market bubble-and-bust scenario – and it seems somewhat bizarre that the Chinese authorities believe they can, or should, get in the way.
But three pieces of context are vital when making sense of the official reaction. First, China’s is not a normal Western-style stock market. The effective free float of the two indexes is less than half the outstanding market capitalisation – 35 per cent in Shanghai and 44 per cent in Shenzhen, according to estimates from analysts at the Australian bank Macquarie. That compares with the 94 per cent free float of the New York Stock Exchange and about 90 per cent for the FTSE 100.
This low free float is because the Chinese indexes are stuffed with companies in which the state retains a controlling stake. It is as if half of the businesses in the FTSE100 were like Royal Bank of Scotland (albeit that the Chinese government is not seeking to divest its stakes). So the market falls represent not only the paper value of the Chinese private sector taking a hammering, but the value of the state sector too. And it is perhaps not surprising that officials aren’t keen to see that.
Second, there is the nature of the Chinese investor ecology. It is impossible for most ordinary Chinese to move their money out of the country. If they leave their money as cash deposits in the big state-owned banks they get interest rates that are lower than inflation, meaning their capital is being eroded in real terms. Millions have ploughed their savings into residential property in recent years, as well as unregulated savings products. But property prices have been falling since last year. And so-called “trust” products –which are often securitised packages of corporate loans – now have a serious trust problem of their own.
Those two factors are likely to have lured many into the stock market over the past year – and the availability of cheap credit for stock speculation has amplified the affect. Yet capital controls mean Chinese investors cannot diversify their portfolios by buying shares abroad. So when the domestic stock market takes a monumental hit, so does the net worth of many Chinese. For obvious reasons that’s potentially hazardous for the ruling Communist Party.
Finally, one needs to bear in mind that the Chinese economy (which in purchasing power parity terms is estimated by the World Bank to have eclipsed the United States last year) is slowing rapidly. GDP growth in 2014 at 7.4 per cent was the weakest since 1990. It is in decline because the Beijing authorities are trying to pivot from a supercharged investment-led growth to growth powered by middle class consumer spending. A collapse in consumer confidence brought on by a stock market rout will clearly not be helpful on this front. “The evaporation of fortunes of more than 80 million individual investors would pose unthinkable social problems” according to Zhao Xijun of Renmin University’s School of finance.
But Mark Williams, the chief Asia economist of Capital Economics, thinks there is probably a simpler motivation at work: pride. “In our view the best explanation for the leadership’s full-bore response to the market fall is that it feels that its own credibility is at risk,” he argues.
The irony is that the Chinese president, Xi Jinping, came to power in 2013 promising to allow the market to play a greater role in channelling financial resources around the economy. Now the biggest priority of his officials is preventing that market from working. And so far, before the eyes of the whole world, Beijing is failing.Reuse content