Beijing meets its match in the markets

When it comes to resisting powerful forces, the Chinese Communist Party has a pretty decent record. In its nine decades of existence, it has overcome civil war, the disaster of collectivisation (admittedly self-imposed), a student-led uprising and, more recently, the 2008 global financial crisis, which barely put a dent in China’s blistering growth. In recent weeks, however, there is one force the government has failed entirely to hold back: The market.

This is not for want of trying. The authorities have tried everything bar passing a law stating that stocks can only go up. With each iteration, their measures have looked more desperate.

They started with tried-and-tested ruses. They cut interest rates in an effort to make holding cash less attractive and reduced reserve requirements so banks would have more money to slosh about. They have sought to talk up the markets, publishing stories in a compliant press about the upside of shares that were already trading on bulging multiples. They have funnelled pension funds into shares, loosened restrictions on margin trading, cut fees and targeted short-sellers.

More recently, they have suspended initial public offerings, so as not to dilute the market and prodded funds into buying — but never selling — stocks. In what one economist called quantitative easing with Chinese characteristics, the central bank will provide liquidity to a state entity that makes margin financing available to brokers. Rather than reining in the leverage that has engorged a dangerous equity bubble, the authorities are egging it on in the interests of short-term salvation.

It is not working. Since the market peaked in mid-June, after more than doubling in value in the previous 18 months, it has lost 30 per cent of its value. That has wiped US$3.2 trillion (S$4.33 trillion) off the value of Chinese stocks, or comfortably more than the market capitalisation of the French and Spanish stock markets combined. While Europe has been fretting about the potential loss of Greece from the euro, some continental-sized chunks of the Chinese equity market have crumbled into dust.

FAR FROM A WELL-FUNCTIONING CAPITAL MARKET

China’s inability to stop the market rout poses at least three interconnected questions. First, are the authorities in danger of losing credibility? Much of the party’s legitimacy rests on its mostly deserved reputation for technical competence. The actions of recent weeks look reactive at best and ham-fisted at worst. The authorities themselves must take a big share of the blame for allowing the bubble to swell in the first place. Chinese leaders crowed in 2008 at what they rightly saw as the complicity of Western regulators and central bankers in fostering irrational exuberance. Now their own authorities stand accused of the same crime. In deliberately puffing up the market, they helped to inflate a bubble that was bound to burst.

Second is the question of systemic risk. This is smaller than it would be in a purely market economy. China’s total stock market capitalisation — after the recent slide — is 66 per cent of national output. The equivalent figure in the US is 140 per cent. Still, banks and brokerages that have lent for margin trading could find themselves in trouble if borrowers cannot repay. In 2007 and 2008, the Shanghai composite index fell from above 6,000 to below 2,000. That could be comforting. The economy marched on regardless. However, it suggests the current slide could have further to go. This time could be different — in the bad sense. In the previous bear market, the economy was growing at double digits. Now it has slowed to 7 per cent officially. Many who lost money will have less to spend. That could mean less consumption, supposedly the main contributor to growth, as China weans itself off capital spending.

Third is the question of reform. There is a dichotomy. On one hand, China’s market operates in a command economy. On the other — for example, in the lax accounting standards of listed companies — it can look more like the Wild West. In a measure of how much control the authorities are prepared to exert, sensitive phrases — “equity disaster”, “rescue the market” — have been banned from stock market reports.

Sooner or later, the market will reach a floor. Yet, something will have been lost. For all the talk of allowing a greater role for markets, when the going gets rough, the government’s instincts are to step in. That is understandable. But China is far from having a well-functioning capital market. And true reform will have to wait for another day. THE FINANCIAL TIMES

ABOUT THE AUTHOR:

David Pilling is Asia editor for The Financial Times.