The Chinese stock market disaster is becoming increasingly serious. If the stock market and the housing bubbles burst at the same time, in combination with China’s slowing economy, and if this situation is not handled well, China could face 20 lost years in the same way Japan did following the economic bubble that burst in 1989.
According to a Bloomberg report, the market capitalization value of the Shanghai Stock Exchange Composite Index dropped by US$3.6 trillion between its top notation of 5,178.56 points on June 12 and the close of trading on July 9. This is far more than the French annual GDP, which stands at US$2.81 trillion. Almost 1,500 companies with a market capitalization value of US$2.81 trillion have temporarily suspended trading of their stocks.
During this period, the China Securities Regulatory Commission’s (CSRC) measures were feeble, the Chinese Ministry of Finance was busy handling local debt and the China Banking Regulatory Commission (CBRC) and the People’s Bank of China were handling marketization of the interest rate and internationalization of the yuan.
Although interest rates and the reverse repo rate were cut, enough importance was clearly not given to the stock market. Other concerned departments were standing by doing nothing and simply let things take their course.
Between June 12 and July 8, the measures to rescue the market had limited effect: The stock market index dropped rapidly and a systemic financial crisis took shape. The situation is now close to spinning out of control and the problem is quite serious.
Chinese Premier Li Keqiang (李克強) returned from a European visit on July 3, just in time to deal with what stock investors theatrically named “black Friday.” The first thing he did was call a national affairs conference for all concerned ministries and agencies. He took strong action, including traditional financial measures as well as authoritarian administrative control methods, in an attempt to save the market and resolve the crisis.
The CSRC temporarily stopped initial public offerings, while at the same time prohibiting board directors and supervisors holding more than 5 percent of shares in their companies from selling their shares and allowing publicly traded companies to buy back their shares.
Central Huijin Investment Co, a unit of China’s sovereign wealth fund, announced that it would buy shares and invest in exchange-traded funds, and the Chinese government provided unlimited liquidity to China Securities Finance Corp, while at the same time endorsing short-term commercial papers issued by China Securities that are expected to inject 260 billion yuan (US$41.9 billion) through stock purchases by 21 securities firms. The Securities Association of China has said that the goal is to bring the stock index back up to 4,500 points.
Some people have said that providing capital through the central bank to rescue the market in this manner is a Chinese quantitative easing trap. The CBRC is allowing banks to extend expiring marginal loans while at the same time asking them to provide loans to companies buying back shares. The China Insurance Regulatory Commission is asking insurance companies to buy shares, and it is said that they bought shares to a value of 112.1 billion yuan in three days.
Even more crucial, the Chinese Ministry of Public Security has ordered a strict clampdown on short-selling futures contracts. On July 9, these extraordinary measures brought the Shanghai exchange back up by 5.8 percent, which was said to be the biggest gain in six years. Unfortunately, it is still unclear whether these stabilization measures and the suspension of trading by almost half of all Shanghai-listed companies will be sufficient to stabilize the market.
The stock disaster has put the spotlight on shortcomings in China’s financial system and market mechanism, and almost undone Beijing’s efforts to implement financial reform and deregulation in recent years.
The current financial management framework is divided into different industry categories. The bank, securities and insurance regulation authorities and the central bank all work independently of each other as if they had forgotten the cross-industrial integration that has taken place since the 1990s, creating blind spots for traditional management practices. This environment requires a unified financial management framework.
At the same time, the regulatory authorities are maintaining order during the regulation of the financial sector, and they should not intervene directly in day-to-day operations. There is a certain agreement as to which methods can be used and which should be avoided in the handling of a financial crisis. China’s attempts to rescue the market consist of intervention and arbitrary changes to the rules, which only increases the risk and is avoided by international markets. If this approach becomes permanent it will become a major obstacle to financial reform. The question is: How long will the government be able to intervene in the market with such strong measures in an attempt to create a bull market, and can this approach help calm the market? This will be the next problem the authorities will have to address.
The crisis is the biggest challenge that socialism with Chinese characteristics has faced since it began its conversion toward capitalism. The road to reform and deregulation will not be smooth.
Norman Yin is a professor of financial studies at National Chengchi University.
Translated by Perry Svensson
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