C3S Paper No. 0008/2016
In July last year stock markets exploded in China and began to test the determination of Chinese authorities to stay on course on reforms. Ultimately, they could not leave it to the market and had to intervene to stabilise the market. There was direct bailout. A ‘national team’ consisting of development banks was formed to acquire shares. It bought nearly 6% of the shares. A ban was imposed on sale of shares by major shareholders. The ban was to end by December 2015. By August, China was able to bring about stability; but at a very high cost. Stock values were wiped out by nearly $3 trillion or 50% in value. China also announced the adoption of “circuit breakers” to come into force from January 1, 2016. Many felt that it was an uneasy peace.
When the markets opened on January 1, multiple forces were at work. Adding to the agony of slow down in growth was the fear of shrinkage in manufacturing as reflected in PMIs. Yuan was losing value vis-a-vis the dollar which was gaining strength. Crude oil price hit $35 per barrel for the first time since 2004. What actually triggered the stock “fireworks” as described by some analysts was that the ban on sale would end and there would be a surge in sales. Rather, it created panic and the market values surged. The stock price rose by 5 % within five minutes and the circuit breaker was applied. Trade commenced afterwards and crossed 7% soon and trading was initially halted and closed for the full day.It happened on Thursday also and the shutters were drawn. The “national team” is expected to intervene. It is unclear how long it would last and what the price would be.
The stock market episode is truly a reflection of the dilemma facing the Chinese authorities. Western type of stock market is unsuited to Chinese conditions. In recent decades there is excessive rein for financial flows (both domestic and external) which creates a mismatch between finance and the “real” economy. China is under pressure to put through financial reforms which include a well ordered stock market. More than 80 per cent of shareholders are individuals (though they constitute 6% of China’s population) and for these millions of share operators stock market is a casino! Sadly, China cannot live with a stock market or live without it!
In other words, China is caught in trap which is of its own creation. As Orville Schell diagnosed in July last (Why China’s stock market bubble was always bound to happen, The Guardian, 16 July 2015): “To have a capitalist stock market being played like a casino by tens of millions of freebooting speculators right in the middle of a society still purporting to be socialist and run by a communist party with deep affinity for rigid, Leninist, interventionist controls speaks to the contradictory nature of the modern Chinese dilemma.” It lies at the heart of “uneasy fusion of communism and free-market economics.” Thus, when Chinese leaders, especially Mr. Xi, cherish the American dream of share market with shareholders, they are driven to intervene massively to hold the market and stabilise it at great cost.
Prof. Michael Pettis was more perceptive in analysing the stock market crisis. As he said, “The financial system is structured in such a way that makes it increasingly difficult to withstand the slowing growth and rising debt burden that is all but inevitable over the next 3-4 years. The historical precedents suggest that Beijing will be overly confident about its ability to manage financial instability, but this creates the risk that at some point it will not be able to do so.” (Interpreting information in China’s stock markets – http/blog-mpettis.com/author/michael-pettis/, July 4, 2015)
There have been debates at higher policy making levels among the Communist Party (CCP), intellectuals and academics. In all these, the Peoples’ Bank of China, in particular its President Dr. Zhou, seems to have carried the day. This was driven by the over arching ambition to have the Yuan included in the SDR and its internationalisation. It is indeed a sorry state that stocks collapse and Yuan depreciation should have occurred within a week of IMF’s acceptance of Yuan’s privileged status.
There is the larger issue of the impact of this crisis on other countries. On the 4th as well as on 7th, global stock markets were rattled beyond measure and stocks lost around $2.5 trillion in value. Market slide has been varied in markets stretching across Asia to Europe and US. Sensex ended 2.18 per cent and Nifty at 2.23 per cent. This is 19 month low. The Rupee has also been affected along with other Asian currencies. Rupee touched a three week intra-day low of 66.96 to a dollar as foreign funds continued their exit from emerging markets. There is complacency among Indian policymakers that India is insulated. This is not so. Capital outflows from EMEs had commenced long before China’s stock market hiccups and were triggered by longer-term factors such as China’s slow down, European malaise, fall in crude oil and commodity prices, export contraction, etc. Stock collapse added fuel to this fire. Another (major) contributory factor is that equities are held by institutional funds which sought higher returns in the past years. Now they are in panic and are shifting funds back to safe havens affecting both currency and stock market values in EMEs. There is her mentality coupled with latter day “flash trading.” Even Goldman Sachs which espoused BRICS countries as the rising sun for western investors had to close down its funds devoted to BRICS countries.
There is a contrary view expressed by Nicholas Lardy, a reputed China hand, that “Global Markets Overreact Once Again.” (Peterson Institute for International Economics, China Economic Watch, January 4th, 2016). As he explains, stock price decline of 43 percent “had little measurable effect on China’s real economy” .In the third quarter, the services sector strengthened on the back of stronger private consumption expenditure. This expenditure is bolstered by growth in disposable income which has been quite strong and the saving rate continues to be high. Only six percent of households have exposure to stock markets. Therefore, there is less evidence of “wealth effect.”
The argument over China’s managing the stock market has been posed trenchantly by Bloomberg. (Bloomberg QuickTake, China’s Managed Markets, Steering through a slowdown, Jan. 5, 2016.) Indeed, China’s intervention in the stock markets questions the credibility of its efforts and, rather, fuels volatility in global markets by sending confusing signals. “The support raises questions about the commitment of its leaders to move to a system where money is priced according to risk and allocated via independent forces, rather than channeled to support asset prices or state-owned enterprises at the government’s bidding.” “They are well aware that moving too quickly to loosen controls, or mishandling the process, could spur turmoil”
As explained earlier, the fusion between capitalism (with Chinese characteristics) communism (even of a diluted version) has become difficult and is throwing up newer challenges. This may well become a part of the ongoing debate within China on the progress of “reforms” laid out in the Third Plenum . It is a test of President’s Xi’s leadership.