The stock market tumult in China has produced mixed emotions. Apart from the anxiety it has caused among fund managers, it has generated euphoria among several Western commentators delighted at the fall of the ‘infallible’. Those confident about the resilience of the Chinese economy, while not running low on such confidence, are uncertain whether the stock market can figure among the economic successes attributed to China over time. And in addition to these prevailing sentiments, there is overwhelming confusion among many over what exactly is happening in the Chinese stock market; and why it is capturing headlines at a time when Greece should have monopolised attention.
Facts point to a rather gory state of affairs in the Chinese stock market. Evaporation of $3.5 trillion of market value—an amount almost double that of India’s nominal GDP—is a shocking revelation of the erosion in investor wealth. There’s considerable speculation over whether the damage will be more in the weeks and months to come. To many, though, more than the wealth wiped out, what has been more intriguing is the way China has gone about mending the market. These include measures ranging from the CSRC (China Securities Regulatory Commission) prohibiting shareholders with more than 5% stake from selling stocks for 6 months resulting in more than 1,000 companies announcing trading halts; and more than 20 securities houses being told to invest 15% of their net assets thereby mobilising around $20 billion liquidity for the market.
There is no surprise in the Chinese authorities stepping in to stem the bloodbath. What is surprising is end they wish to achieve. All the measures taken are aimed at ensuring the bubble created in the Chinese equity market since early 2014 remains as full blown as it was.
The global financial crisis of 2008 saw China responding by unleashing a huge economic stimulus. A core part of the stimulus was monetary expansion. Chinese banks were recapitalised to ensure they kept on injecting liquidity into the economy so that aggregate demand did not choke at any point in time. Chinese brokers are expected to play a similar role this time around through their investments in the stock market. The problem is banks and brokers are not exactly similar actors when it comes to their roles in an economy. While both are intermediaries, banks have traditionally been policy tools for almost all countries in serving monetary policy objectives. Brokers and security houses hardly perform such roles. China is relying upon these houses to do for the stock market what its banks had done for the rest of the economy earlier.
Maintaining the bubble in the equity market is important for China given the high stakes riding on it. Domestic retail investors are the largest contributors to market capitalization in China. These investors not only account for more than 80% of total market capitalisation, but also a similar share of the total traded volume. This is in sharp contrast to other emerging markets where retail investors account for around 35% of market capitalisation and 45% of trading volumes.
The stock market frenzy over the last one year and a little more has seen an enormous number of new ‘rookie’ accounts getting registered for trading. A significant part of the new investor households opening trading accounts have only elementary school education. As it is, even among earlier existing investor households, the proportion of graduates was only 8.4%. It is clear that Chinese household investors with limited education and skills have been turning to the stock market for income. The size of the domestic retail investors has also been bolstered by the large presence of individuals who have put in their hard-earned savings in hope of high returns.
Compared with other emerging markets, particularly India, the Chinese stock market is conspicuous by limited presence of domestic and foreign institutional investors in building market size. These two categories account for just over 15% of the equity market in China, while—on an average—in other emerging markets, they represent around 65% of the market cap. This peculiar character of the Chinese market is a result of the limited financial sophistication in the Chinese economy allowing households practically no long-term institutional savings options. As a result, households of all hues and colours have been flocking to the stock market. These particularly include relatively poor and less educated households that do not have enough means for investing in real estate. Lack of adequate institutional reforms by Chinese authorities have not allowed foreign institutional investors to step into the market in a big way for diversifying its wealth base. There is therefore no alternative source of private institutional wealth that Chinese authorities can tap for shoring the market forcing them to fall back on domestic security houses.
There is little wonder then that Chinese authorities have pulled out all stops. The amount of damage suffered by household investor wealth following the wipeout of $3.5 trillion from a market of around $6.5 trillion is understandable. Any further damage to household wealth is non-negotiable for the Chinese authorities. But the larger question is how long would Chinese households be able to draw oxygen from a stock market running on artificial life support.
The author is senior research fellow at the Institute of South Asian Studies
in the National University of Singapore. E-mail: firstname.lastname@example.org.
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