By Michael Lelyveld
Steep drops in China’s stock markets have shaken trust in the country’s economic management following a series of missteps and measures to avert further falls.
The plunge of over 30 percent in the Shanghai Composite Index (SCI) between June 12 and July 8 has made a lasting impression on China’s investment environment, despite government efforts to provide support.
Never mind that the SCI more than doubled in the previous 12 months and remains above the 3,000 mark that was considered a psychological breakthrough level late last year.
And never mind that the government responded with a barrage of intended fixes and capital infusions to slow the slide and stage a partial recovery.
The first flurry of government remedies did little to help small investors who lost savings by buying into the market at the peak and then were unable to get out when it plunged.
Many borrowed on margin accounts and then were shocked when their stocks stopped trading after reaching the 10-percent daily limit for declines.
A series of unprecedented rescue efforts have had mixed results.
On July 4, China’s regulators stopped 28 companies from launching planned initial public offerings (IPOs) out of concern for diluting the market.
The government also pushed 21 brokerages to invest 120 billion yuan (U.S. $19.6 billion) in exchange-traded funds (ETFs), hoping to buoy the sinking boat with liquidity from the China Securities Finance Corp. and the central bank.
The SCI responded only briefly on July 6 with a 2.4-percent gain, but shares slipped back as debt fears and economic gloom returned.
By midweek, over half of the listed companies on China’s exchanges had filed for trading suspensions to limit their losses.
Estimates of lost stock value topped U.S. $3 trillion (18.6 trillion yuan), equal to nearly 29 percent of China’s gross domestic product (GDP) last year.
Further rescue efforts followed but failed to restore confidence.
At first, the government “ordered” state-owned enterprises (SOEs) and “asked” state-owned financial companies not to sell shares during the downturn, the official Xinhua news agency said.
Regulators also “allowed” government pension funds and insurance companies to buy stocks with eased rules.
But the market only rebounded on July 9 with a 5.8-percent gain after the government stacked the deck with measures that virtually guaranteed that there would be more pressure to buy than to sell.
Among the more controversial moves, large shareholders were “ordered” not to sell company stock for six months, while police vowed to investigate and punish “malicious short selling” by investors who hoped to profit from price declines, Xinhua reported.
On Friday, the SCI climbed 4.5 percent, closing up 5.2 percent for the week but 25 percent below this year’s high.
The two-day rise “to some extent helped restore shattered confidence,” Xinhua said in a commentary.
On Monday, the rebound continued with a 2.4-percent rise as some issues lifted the freeze on their shares.
But in a classic case of bad timing, the pitfalls of China’s economy have come into focus and contrasted sharply with the image it has been projecting abroad.
“We’re talking about China taking a leadership role in the world at a time when China’s economy is stagnating,” said Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute (AEI) in Washington.
While the debacle in stocks may not be a measure of China’s long-term prospects, it has been seen as a black eye for the economic management of President Xi Jinping and Premier Li Keqiang.
Premier Li was “very angry” that the crisis struck just as he was returning from a five-day visit to Europe aimed at promoting investment and trade, according to a source “familiar with the trip,” the Financial Times said.
Li’s mission to Belgium and France was one of several recent efforts to push China’s economic power to the front of the world stage.
In May, Li also toured Latin America offering trade and investment partnerships. Last month, Xi and representatives of 56 other countries launched the China-led Asian Infrastructure Investment Bank (AIIB) as a major development initiative.
Despite the troubles at home, Xi traveled to Ufa, Russia last week for meetings of the Shanghai Cooperation Organization (SCO) and the emerging BRICS countries, including Brazil, India and South Africa, to announce new financial institutions that may compete with the International Monetary Fund and the World Bank.
One interpretation is that Xi may only have shaken confidence in the market further if he had cancelled the trip.
On Friday, The New York Times reported that “perhaps no one has taken a bigger hit” to his image than President Xi as a result of the market crisis.
Other reports suggested that Xi sought to place the responsibility for the plunge on Premier Li and left him to work his way out of it on his own.
While Xi and Li have tried to portray China’s economy in a favorable light to foreign audiences, its weakening growth has produced some suggestions that it is struggling to stave off instability.
“The Chinese economy is generally stable in the first six months,” Li told a business summit in Toulouse, France on July 2, the official Xinhua news agency reported.
“We have confidence in achieving the goal of around 7 percent growth for the whole year,” he said.
The extent of the market’s damage to the economy has yet to be seen, but it may already have shelved the government’s plan to promote private investment through “mixed ownership” of SOEs, which may now be barred from selling shares.
On Friday, China securities regulator said “there will be no IPOs in the near term.”
While insurance companies have reportedly bought stock, it is unclear how much additional risk financial institutions will be willing to take.
The official English-language China Daily cited “fears of rising bad loans in the banking sector, since many listed companies have used their shares as collateral to borrow money.”
‘Immature’ financial system
In the end, China’s market turmoil may have relatively little economic consequence, despite the pain for investors, Scissors argued.
“This has to do with an immature financial system, which the Chinese aren’t fixing,” he said.
China’s markets have followed a boom-and-bust cycle, last seen in October 2007, when the SCI plummeted 71 percent over a one-year period after soaring fourfold since the start of 2006.
Despite the slump, China’s GDP climbed 13 percent in 2007 and 9.6 percent in 2008, according to National Bureau of Statistics (NBS) data.
But with GDP growth in 2014 falling to a 24-year low of 7.4 percent and a six-year quarterly low of 7 percent in the first quarter, investors will be looking anxiously at second-quarter figures due to be announced later this week.
The longer-term weakening of China’s economic growth remains the main consideration, Scissors said.
In a Washington Examiner article last month, AEI analysts cited the China slowdown as a major challenge to the notion that this will be the “Asian century.”
“While economists have accepted that China is perhaps heading toward long-term stagnation, the foreign policy community is stubbornly resisting the new reality: A Chinese slowdown is becoming a defining fact of Asian geopolitics,” the authors wrote.
“Without China, there is no Asian century,” they said.
Whether the market crisis will cut deeply enough to affect China’s many international investment plans is uncertain, but the sheer number of them suggests a possible pullback if the stock slide is prolonged.
In addition to the AIIB and BRICS funding, China has been promoting its “belt and road” initiatives to recreate ancient Silk Road trade routes and an “industrial capacity cooperation” program to build manufacturing bases abroad.
The threat of a serious economic setback could follow the pattern of 1998, when the Asian currency crisis delayed China’s “go out” plan for foreign energy investments by several years.
In the current downturn, China’s partners will be looking to see how well it performs as an emerging world financial center and how much it relies on interventionist, arbitrary and non-market policies. Some of its moves have already proved contradictory and self-defeating.
The government’s infusions of liquidity into the falling market serve as a reminder that Li complained only three months ago that state banks were more interested in lending for stock market speculation than in financing to support the “real economy.”
Now, the government has called for more lending to buy shares and avoid a market collapse.
On April 17, regulators also tightened margin trading rules and allowed funds to lend shares for short selling in a bid to bring the stock market bubble down.
Now that the bubble has apparently burst, regulators have reversed course, pumped more funds into margin trading, blamed short sellers for the crisis and threatened them with prosecution.
Last week, Bloomberg News suggested that “government meddling is making matters worse.”