China’s Searching for Stock Market Scapegoats
To commemorate the 70th anniversary of Japan’s World War II surrender, China planned a 12,000-soldier march down Beijing’s Chang’an Jie—Eternal Peace Street—on Sept. 3. For President Xi Jinping, it was a chance to project an image of calm, order, and strength. Unfortunately for Xi, China’s financial markets are sending a completely different message.
Since the stock market started melting down in mid-June, wiping out $5 trillion in shareholder value, the government has tried a series of increasingly desperate measures to halt the slide. The latest looked like an attempt to shift blame: In a campaign to crack down on alleged market manipulation, it arrested executives at Citic Securities, China’s largest brokerage, an employee of the China Securities Regulatory Commission, and a journalist at Caijing, a business magazine.
The Citic executives, including Managing Director Xu Gang, admitted insider trading, according to Xinhua, the state-run news service. The journalist, Wang Xiaolu, admitted wrongly reporting on July 20 that the CSRC was studying whether to end stock market support measures, causing panic and confusion, Xinhua said. A Citic representative declined to comment, and Caijing didn’t answer calls. The magazine has said it will cooperate with authorities.
The government also continued to intervene more directly. It ordered brokerages to contribute an additional 100 billion yuan ($15.7 billion) into a stock market rescue fund. In the currency market, the government has spent hundreds of billions of dollars to stabilize the yuan following a surprise devaluation on Aug. 11. And the People’s Bank of China (PBOC) cut interest rates on Aug. 25 for the fifth time since November. Still, investors weren’t impressed: The Shanghai composite index fell 2.2 percent in the three days leading up to the victory march. It’s now down 39 percent from its June peak.
Xi’s government is struggling to balance a pledge to loosen its grip on the economy with the desire to ensure stability and maintain confidence in the ruling Communist Party. The battle between the invisible hand of the market and the iron fist of the government creates confusion and chaos, making China the biggest threat to the global economy and financial markets. “They don’t quite get how to work with these markets, don’t know what they’re doing—that view is already out there,” says Nicholas Field, emerging-markets strategist at money manager Schroders in London. “It’s one of the reasons why global markets have sold off.”
When Xi came to power in 2012, he had a different vision. He rounded up corrupt officials, flexed muscles in territorial disputes with neighboring countries, and pushed to reshape the global financial landscape by establishing the Asian Infrastructure Investment Bank.
With the economy growing at its slowest pace since 1990, Xi’s administration pledged to let market forces play a bigger role to unleash China’s potential. Foreign investors were allowed unprecedented access to the mainland stock market, while policymakers pushed to make the yuan a global reserve currency and lobbied companies that create investment indexes to add China to their benchmarks. Through policy changes, official statements, and articles in state-run publications, the government encouraged the public to buy stocks. Throngs of rookie investors piled in, many using borrowed money, helping to send the Shanghai composite up more than 150 percent in a year.
When the debt-fueled rally turned into a rout for China’s 90 million individual investors, the government moved to stop the bleeding, putting its credibility on the line. Officials banned large shareholders from selling stakes, ordered state-run institutions to buy stocks, and allowed more than half of listed companies to halt trading. As the plunge continued, the devaluation of the yuan shocked global investors, deepening a selloff in emerging-market currencies and erasing $7.7 trillion in global equity value. The PBOC has since tapped its $3.7 trillion in reserves to steady the yuan.
Many economists and strategists say the stock intervention measures are temporary and Xi will press ahead with reforms once calm returns. “They are not going to permanently go back to full state control,” says Clement Miller, an investment strategist at Wilmington Trust. “They’ll move in the direction of market-oriented measures, but this is definitely a delay and setback.” In a deregulatory move in late August, the central bank removed the interest rate cap on savings deposited for more than one year. The yuan devaluation was accompanied by reforms meant to give market forces more influence over the exchange rate. “I’ve always been a great believer in Chinese pragmatism, just considering what they’ve done over the past 30 years,” says Enzio von Pfeil, Hong Kong-based investment strategist at advisory firm Private Capital. “Yes, reforms will continue.”
The confused response to the market slump has shifted long-held perceptions that the Chinese government is in firm control of the economy and knows how to maintain stability. Even as China gave market forces a bigger say and welcomed global investors to its once-isolated markets, its policymakers have been caught unprepared in areas such as regulation, crisis management, and communication with the public. Investors are getting mixed signals about the government’s intentions, and many are left to speculate about whether the rescue measures are designed to support specific price levels for stocks or simply to reduce wild swings in the market. And if the government truly wants the yuan to be a freely traded global currency as it claims, why is the central bank intervening in the market to support the exchange rate so soon after a devaluation? “The interventions are damaging China’s credibility as a legitimate investment market,” Miller says.
There are few signs the volatility will soon die down. Even after the swoon, stocks in the Shanghai composite are expensive. At 24 times projected earnings for the next 12 months, the median price-earnings ratio of companies in the benchmark is almost 50 percent higher than that of companies in the Standard & Poor’s 500-stock index.
In the foreign exchange market, traders are bracing for more declines in the yuan, because new data on manufacturing and exports are likely to provide additional evidence of a slowing economy. Bets on the currency known as 12-month nondeliverable forwards indicate traders are expecting a decline of about 4 percent in a year. Michael Wang, a strategist at hedge fund Amiya Capital in London, says the government will have to learn to live with the volatility, the natural consequence of unleashing the market forces. “They are now realizing that it will be harder than they thought, and they are retreating from that strategy” of heavy-handed intervention, he says. “But the damage is done in terms of perception.”
—With Belinda Cao and Kana Nishizawa
The bottom line: With $5 trillion in stock market value having disappeared since June, China’s government is looking scared and confused.