New Delhi should take greater interest in the enormous stock market crash in China than events in tiny Greece. The original crash wiped out $3.2 trillion from China’s main stock markets — notionally an amount worth over a dozen times Greece’s entire GDP. Beijing has virtually shut down the stock markets since then and through a number of government interventions, including forcing state-owned firms to buy stocks, will begin to force up the market. But it has probably only postponed a further correction or transferred the damage from the book of stock investors to those of government entities.
The real impact of China’s stock market crash will be less on the fortunes of domestic and foreign investors but on the future of Xi Jinping’s economic reform programme. This, in turn, will be the key determinant of the trajectory of China’s future economic growth. The stock market crash has taken place just as China’s leadership is meeting in Beidaihe to decide on what steps to take to revive the country’s flagging economy.
The Chinese Communist Party’s Third Plenum had promised to allow ‘market forces’ to govern economic decisions. This was more than ideology: The original State-driven investment model is slowly running out of steam and Beijing accepted that this had to change. Both the passive response to the stock market bubble and the means that Beijing has tried to arrest its bursting were textbook examples of non-market based policy responses. Beijing seems to have let the bubble grow because it saw an opportunity to inflate the wealth of State-owned firms and reduce their debts. It then intervened in a manner that has now generated a new layer of debt, largely in the manner of money borrowed to buy inflated stocks.
The sense that this has all been about saving the commercial interests of the communist party rather than managing the economy is difficult to escape. Clearly, independent regulation was wholly lacking when the bubble began to expand and ‘market forces’ were the last thing on Mr Xi’s mind when Beijing moved in to arrest the collapse. There had been expectation of a raft of new reforms in the latter part of this year, especially in finance. It is possible Mr Xi will plough forward anyway, possibly freeing interest rates and allowing Chinese savings to be invested overseas, but the credibility of his reform pronouncements has taken a severe beating. In his first domestic economic crisis, the Chinese leader failed to live up to his own words. He will have to double down on his reforms to make up for this debacle.