In the past two months, the Asian stock market has witnessed the greatest market fall since July 2007. The collapse of the Shanghai indices that begun in mid-June has ended with listed companies loosing up to $3tn. The Chinese stock market bubble, as described by European analysts, has burst after almost a year-long bullish market ambiance and is still awaiting the recovery. Hence should the Chinese government aim for a market recovery or leave the market to the invisible hand mechanism in accordance with Adam Smith’s philosophy?
It is crucial to answer what really happened in the Chinese stock market in the past few months? So far, we know that by 9th July, the Shanghai stock market fell by 30% over a three week-period and investors were forced to take on short positions. Paradoxically, these were predominantly the investors who pumped up the bubble so rapidly. They were irresistibly continuing to inflate the market through mass investment in stocks whose owners had no profit cover.
Additionally, in order to encourage foreign investments, the authorities had purposely eased borrowing measures and facilitated market investments through home collateral. One could take on a loan to invest by using their own real estate as a warranty. The aforementioned reasons culminated in a remarkable peak in Asian markets in mid-June 2015.
The bullish market begun when the Shanghai Composite Index crossed a level of 4,000CHY eventually reaching 5,166.355 CHY. Simultaneously Western analysts believe it was not solely speculative investments but rather heavy-handed government interventions. Chinese government is said to manipulate its monetary-based interventions, as well as the money supply, in order to stimulate market conditions.
Nevertheless, after the Shanghai bubble as it’s now called, the government appears to seek more security and stability turning its attention towards raising investor confidence, through bonds. It is well-known that the Chinese bond market is the 3rd largest in the world, amounting to almost $4.24tn and is right after the US and Japanese markets. The most difficult decisions are yet to be made by President Xi Jinping, but financial bonds depict the clearest solution.
In the first week of August, the government proposed a 10-year (or even longer) Infrastructure Bond plan. From a technical viewpoint, as to start the programme, the Agricultural Development Bank of China and other development banks will issue 300bn out of 1tn yuan, as the first batch. Bonds will be issued in multiple tranches, but the first one is planned before September. Most of the issued bonds will then be purchased by the state-owned commercial banks thus increasing their capital base and an ability to take on more debt.
An issue of the new bonds aims to increase funds for the infrastructure spending. Money is planned to be invested in housing, pipeline infrastructure and other domestic projects. According to one of the Chinese journals, 14 provinces are likely to invest 15tn yuan on infrastructure equal to almost 25% of a total national Chinese economic output. To what extent will those investments be sustainable and cost-efficient?
According to Andrew Batsal from the Gavakal Dragonomics, bringing up the prior years interventions in the public sector, he believes the solution of backing up of infrastructure by the local government proved to be unsustainable in the long term. Moreover, the Asian real estate market has witnessed an unbearable decline and urban investment growth fell to a 14-year low of 11,4% in July of this year. This is likely to be a direct consequence of a foreign investment deficiency, fostering a need for a change in strategy from investment-based to more economically autonomous.
In addition to issuing bonds, the government reacted almost instantly to the decline in the Shanghai indices and has limited scalping practices under the threat of arrest. Additionally, under Xi Jinping’s governance, the expansionary monetary policy of interest rate cut has been initiated. The move is meant to boost the investments and export-led growth through a decrease in the exchange rate. The drawback of that could be naturally an artificial and exceeded yuan devaluation, later subject to a potential legal prosecution.
Naturally the critic appears to be inevitable as usual. According to Rajiv Biswas, the Chief Asia Economist for HIS Global Insight:
“Even if they do announce monetary stimulus and fiscal stimulus measures, it is going to take some time before those really have any impact on the economy”
“There are a lot of different parts of the economy that are showing weaknesses and the collapse of the stock market is just another symptom of the fragility of the Chinese economy right now”
He also believes a market correction is necessary, but it’s likely to do little to prevent further stock falls. Following on the words of Rajiv Bitsaw, are the efforts of market recovery sufficient to rebuild the pre-crisis stock market level? And most of all, does the Chinese economy need an absolute reformation to overcome its current weaknesses visible in a plunge of economic growth and declining foreign investments? At present, in the already quite centralised stock market, government intervention is not only unsurprising but seems to be unavoidable.