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‘China’s stock market effectively broken’: Decoding the China rout

China’s major stock indexes opened higher on Friday after Beijing ditched a circuit breaker mechanism that halted trading twice this week when share prices tumbled and had been blamed for exacerbating the market sell-offs

business Updated: Jan 08, 2016 09:42 IST
Mercator Institute for China Studies
Mercator Institute for China Studies
Sebastian Heilmann is the founding director of the national Mercator Institute for China Studies (MERICS) in Berlin
Sebastian Heilmann is the founding director of the national Mercator Institute for China Studies (MERICS) in Berlin ( )

China’s major stock indexes opened higher on Friday after Beijing ditched a circuit breaker mechanism that halted trading twice this week when share prices tumbled and had been blamed for exacerbating the market sell-offs.

Chinese markets have had a turbulent start to 2016, buffeted by the PBOC’s lower yuan fixings against the dollar, two days of stock exchange suspensions, weak factory and service sector surveys and worries about looming share sales by major stakeholders once a ban on such sales expires.

Shareholders and investors in China have been shaken by these developments.

Hindustan Times is repurposing an interview with Prof Sebastian Heilmann, Director of the Mercator Institute for China Studies (MERICS) in Berlin, about the matter.

What do you make of the current developments?

China’s stock markets are effectively broken. They have always been regarded as something of a casino. But now they have become much too risky, even for speculators. The Government’s competence in economic policy has taken an undeniably hard knock because of the stock-market crashes people have kept on seeing – the efforts it has been making ever since last summer to get the stock market under regulatory control and bolster it with the help of huge cash injections have all come to nothing. Various other economic indicators also show that the Government’s measures to stimulate economic growth have not had as much of an effect as it hoped.

How important are the new stock-market regulations on suspending trading and the restrictions on selling shares for large shareholders?

The new rules on suspending trading in the event of above-average share-price losses have made the pressure to sell quite acute. What especially triggered the latest crash was the pending reversal of the existing ban on sales of shares by major shareholders. The Government’s decision to set rather arbitrary trading restrictions of this kind that run counter to stock-market dynamics has had a highly negative effect, as big and small shareholders alike then chose to take out the share-price profits they had seen in the final months of 2015. They therefore sold their shares at the earliest opportunity this year, just before the reversal of the immobilisation period for major shareholders, which has the potential to bring about another round of drastic market correction.

What does the stock-market crash mean for China’s real economy, which appears to be slowing progressively?

The condition China’s stock markets are in has never been a direct reflection of how its real economy has developed. The Chinese Government rather wanted to employ them as a means of raising capital for often debt-ridden state-owned enterprises. If neither the stock markets nor banks can serve as a reliable source of capital for major enterprises any longer, then this will have a decidedly negative impact on the growth of the economy.

So what needs to happen to revive the stock market, then?

Shareholders’ trust will only be won back again if every listed company is obliged to make encompassing reports on its business operations that are independently scrutinized by trustworthy regulators, auditors and market participants. On the basis of this, it would be possible for a firm’s share price to be re-evaluated – or even for it to withdraw from the stock market altogether. Piecemeal intervention by the regulator won’t make up for what trust has already been lost. The Chinese Government needs to make the stock market and listed businesses subject to a completely new set of rules and regulations. Since it wishes to retain political control over the stock market, however, it’s unlikely that any far-reaching steps of this kind will be taken.

What kind of political effect will this dramatic situation have, do you think?

It’s likely that some political pawns will be sacrificed. I expect reshuffles in the China Securities Regulatory Commission or even among top-ranked economic policy-makers. It’s quite likely that a close associate of Premier Xi Jinping’s will take over as director of the Regulatory Commission. This step won’t make the market calm down for long, though. What’s more, the obvious failure of market regulation may also destabilise the political situation domestically. The loss of control apparent in economic policy and the much greater risks that now exist for the ruling elites, which have a lot to lose as a result of the economic slowdown and growing uncertainty, all add up to a dangerous mix.

What should European investors and entrepreneurs be prepared for?

I reckon investment activity in China will drop quite significantly due to growing uncertainty in many Chinese businesses. Germany’s car-manufacturing industry, mechanical-engineering sector and chemical industry are particularly vulnerable to negative developments in the PRC.

China’s economy is currently in the middle of a major upheaval. Many industrial and financial indicators suggest that the country will have to reckon with a clear slump in economic growth over the next few years. Since China has served as a growth engine for the world economy over the last ten years, any slump it suffers will affect its trading partners and investors, too – firms that have all profited from the recent boom in China up to now.

Conversely, the difficulties now encountered in the Chinese market harbour a number of opportunities for European economies with a view to attracting Chinese outbound investment. European companies, property markets and start-up hubs have the potential to become an ever more important destination for Chinese investors. Overall, I expect more capital to flow out of China. Chinese stock markets may remain in a mess for the foreseeable future. But the age of global Chinese capital investment has only begun.

This interview has been republished with permission from Mercator Institute for China Studies