Chinese stock market: To eat or not to eat the cake? - The Centre for Independent Studies
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Chinese stock market: To eat or not to eat the cake?

ideas-image-150807-2China’s authorities are desperately attempting — and failing — to intervene in its stock market to prevent a much-needed and rational price correction.

The main reason is politics, not economics.

China needs to deepen its market-oriented reforms to maintain a sustainable economic growth path. Yet, easier said than done. Beijing is aware of the need to move from a state-based investment economy — which (over-)invests roughly one in every two dollars produced — towards a more consumption-based economy. The transition is not seamless, and has to go through financial liberalisation (including free floating its national currency).

Nonetheless, wary of past troubled experiences of East European countries and Asian tigers in the 1990s, Chinese leaders are reluctant to move forward, as proven by recent stock market activity.

Despite declining growth rates and ever-increasing international risks, Chinese investors (especially ordinary people without any knowledge of share valuation) jumped into stock markets to capitalise on their savings. The result was an exuberant increase in stock market valuation, more than doubling the Shanghai Composite Index in the last 18 months (see Chart above).

When the recent day of reckoning came, shares fell by a third, wiping out some $3.5 trillion in wealth. This seems a large number, but not when given the previous steep increase in shares and properly put into perspective: less than 15% of household financial assets are allocated in the Chinese stock market, which undermines the contagion to the wider economy.

Instead of letting the much-needed correction to take place, Chinese authorities acted – yet in the wrong way: 90% of all shares listed on Chinese exchanges were suspended or halted; IPOs were prohibited; short-selling outlawed. Also, a share-buying scheme backed by central-bank cash sent the wrong signal for Chinese moms-and-pops that buying shares is a one-way bet.

China needs to deepen economic liberalisation to avoid a sclerotic financial market. For instance, setting free interest rates on bank deposits might be an attractive alternative for ordinary Chinese to park their savings instead of risking on complicated financial waters.