- Officials weigh cost of rescue against risks to banking system
- Shanghai Composite Index has tumbled 15% over two days
China’s decision to halt intervention in the stock market this week reflects a debate at the heart of the country’s leadership on the role of markets in the world’s second-largest economy.
Authorities have refrained from intervening so far this week as the Shanghai Composite Index tumbled at the fastest pace since 1996, according to people familiar with the situation. Some officials argue that market losses will have a limited impact on economic growth and the costs of support are too high, said one of the people, who asked not to be identified because the deliberations are private. Officials who back the rescue effort say tumbling shares pose a risk to the banking system, the people said.
President Xi Jinping’s government is trying to balance a pledge to loosen its grip on markets against the desire to ensure financial stability and maintain confidence in the ruling Communist Party as economic growth slows. The Shanghai Composite sank 15 percent over the past two days, extending a $4.5 trillion rout since mid-June that has shaken confidence among equity investors around the world.
“Government intervention has dropped substantially,” Michelle Leung, the chief executive officer at Xingtai Capital in Hong Kong, said in e-mailed comments on Tuesday. “The reform-minded camp within the government that favors letting the market do its work seems to be driving decision making right now.”
China’s November 2013 pledge to let markets play a decisive role in the economy is being put to the test after a record-long boom in the Shanghai Composite turned into a bust. Officials allowed about half of China’s listed companies to halt trading at one point last month, banned major shareholders from selling stakes, suspended initial public offerings and gave a government agency access to more than $480 billion of borrowed funds to finance equity purchases.
Instead of meddling in the stock market, authorities should focus on monetary stimulus to revive economic growth from the weakest level since 1990, according to Sam Le Cornu, the co-head of Asian listed equities at Macquarie Investment Management. The People’s Bank of China delivered just that on Tuesday, cutting its benchmark interest rate for the fifth time since November and lowering the amount of cash banks must set aside as reserves. Chinese stock-index futures rallied after the announcement, climbing 5.8 percent in late Singapore trading.
The government “buying stocks at this point doesn’t really make a difference,” said Brett McGonegal, chief executive officer at Reorient Group Ltd. in Hong Kong. “The market needed some clarity from the PBOC.”
China’s interventionist response to the equity selloff last month spurred foreign investors to withdraw funds at a record pace and prompted the International Monetary Fund to urge Chinese officials to eventually unwind the measures. China is seeking an IMF endorsement of the yuan as a reserve currency, a goal that some analysts have said is being used by reformist policy makers to reduce the state’s role in markets and open up to foreign investors.
As part of that effort, the government gave international money managers unprecedented access to mainland equities through the Hong Kong exchange link in November and allowed market forces to have more influence over the yuan this month. The increased role of institutional investors in China is making the market more responsive to fundamental drivers such as equity valuations, according to Gerry Alfonso, a sales trader at Shenwan Hongyuan Group Co. in Shanghai.
Right now, valuations suggest shares have further to fall, said Wenjie Lu, a strategist at UBS Group AG in Shanghai. Stocks on mainland bourses traded at a median 61 times reported earnings on Friday, according to data compiled by Bloomberg. That’s the most expensive level among the 10 largest markets and more than three times the multiple on the Standard & Poor’s 500 Index.
“The dilemma for the government is that the more stocks they buy, the less likely the market will stabilize itself,” said Lu, who anticipates a 12 percent drop in the Shanghai Composite.
Proponents of the rescue campaign have argued that a buildup of leverage in China’s stock market had made the financial system vulnerable to a collapse in shares. Margin debt on mainland exchanges climbed to a record 2.3 trillion yuan ($359 billion) in mid-June, before falling to 1.3 trillion yuan this week as the rout prompted traders to close out bets using borrowed money. Margin debt outside official channels may have reached 1.6 trillion yuan in May, according to Credit Suisse Group AG.
“The government intervention was primarily to unwind the unhealthy levels of margin financing,” said Erwin Sanft, the Hong Kong-based head of China strategy at Macquarie Group Ltd. “From that perspective, the intervention has been a success.”
The China Securities Regulatory Commission didn’t immediately respond to a faxed request for comment. On Aug. 14, the CSRC said China Securities Finance Corp., the state agency tasked with supporting share prices, would no longer add to equity holdings unless there’s unusual volatility and systemic risk.
The Chinese government’s current priority is the success of a military parade commemorating the end of World War II on Sept. 3 in Beijing, people familiar with the situation said.
What happens in China’s stock market has a growing influence on public perceptions of the leadership’s economic management after amateur traders piled into shares at a record pace over the past year. Encouraged by a series of articles in state-run media that endorsed equity investment, more than 90 million individual investors now have stock accounts, a constituency that’s bigger than the ruling Communist Party.
For UBS’s Lu, short-term losses in shares are worth bearing if it means the market will play a greater role in setting prices. Along with lower interest rates, policy makers should step up fiscal stimulus to boost economic growth, he said.
“That’s not a direct rescue of the stock market,” Lu said. “But eventually, it will be more helpful.”
— With assistance by Keith Zhai, and Steven Yang