Muses

In this post I would like to focus on a country which has dominated the World Economy like no other country in the last 30 years. I can’t think of any conversation or discussion happening on world stage in the last decade or so where China is not mentioned. After all its a country which did the unthinkable – Clogging a GDP of 7% or more for more than 2 decades is no mean feet. This catapulted it to the 2nd in the World Economic order, some Economists say it will overtake US sooner than later. This is a nation which made manufacturing its foundation and brought millions out of poverty and in this process termed to be called as the “Factory of the World”. 

Everything was going well for China- Cheap labour, Strong domestic demand, Strong Customer Base in Western countries etc. Then came the 2008-09 financial crisis which brought the nations in the developed world into a vicious pothole of recession , low productivity and demand. This naturally had an impact on China and its GDP slowed but still the highest among bigger economies clogging close to 9%. This seemed very impressive in relative terms but gradually things started to slow down further and a GDP of less than 8% became the new norm.

I believe this dip in GDP and the slowing economy prompted the Chinese Government to start focussing more on Financial Services and with it the stock markets. This was a big fundamental shift.
One must also the exchanges started in China in 1990 which is a very late stage entry compare to the developed world and other big economies. The Chinese Stock markets were normally inhabited by business people, foreign investors etc. The prospect of large number of retail investors in the Stock market was not something which China had seen before in its two main land exchanges – Shanghai exchange & the technology heavy Shenzhen stock exchange.

In addition to two mainland exchanges China also has the Hong Kong exchange. The Hong Kong markets were always watched carefully by Chinese investors and had developed lot of curiosity.
The handover of Hong Kong from the British made the Chinese more proactive in Hong Kong and its  financial markets. A sort of competition started between the mainland stock exchanges and the exchange at Hong Kong. The Government started to get involved more and more in the functioning of the markets and viewed it as another medium to attract investments.

Causes of Stock Boom : There were several causes for the stock boom :

1. Easy Regulations: The Chinese Government subsequently made regulations which were attractive for investors both Big and Small to invest in the markets. The rules for the IPO were relaxed which made lot of companies come to the market to raise money.

2. Cheap Credit :The availability of cheap loans to investors made investing more and more easy and fascinating. Many state run banks did fund the cheap loans.

3. Hong Kong – Shanghai Connect :The decision to make a connect between the Hong Kong exchange and the Shanghai exchange in 2014 further fuelled a further boom in the stock markets. All these steps made a relatively new exchange (Shanghai exchange) one of the biggest in the world. The party was in full swing and the mainland exchanges gained over 100% since 2014.

4. State Backing : The Chinese state run media also encouraged such a boom and everyone seemed to be bathing in the glory without realising the downside. The investors particularly the retail ones believed the Government would do every possible thing to continue this boom. They kept on taking cheap money and start pouring in the markets making the stocks they invested highly over valued. Gambling seemed to favour Financial rationale.

Then comes the rude shock, which many analyst seemed to predict correctly. The markets started to enter a bear market. The corrections in the market were severe and wiped out 30% of the market in less than a month. Its an incredible fall by any standard. So what brought the Stock market party to such an abrupt end.

Many reasons were floated to attribute to such a crash land:

1. Slowing Chinese Economy – Although this factor had historically been neglected by investors in the stock market. It seemed to have weighed on this time with GDP growth falling to 7%

2. Clampdown on Margin Lending – The markets were fuelled by retail  investors armed with cheap margin lending. Unfortunately when investments failed or were not upto the mark, the retail investors were either forced to sell or unwind the trading practice.

Government Response : The Government took a slew of measures to curb the downfall in the market.

1. Rate Cut :The prominent of them being a rate cut to make liquidity available in the market.

2. Government backed buying : Government backed Brokerage and state firms buying stocks.

3. Market Regulator Action:  Suspension of share sell and new IPO’s.

4. Government Tough Warning :The Government issued stern warnings to manipulators and short sellers which seemed to have an effect.

The fall has certainly been arrested in last week or so. But the issue is far from over.
Its a classic case of the instigator and the arrester being the same – The Chinese Government.

Solution: Market Reforms 

The need of the hour is the Government make markets more open to scrutiny and transparency which would in the long run weed out speculators and bring in genuine investors. Market reforms are a necessity for China and should be welcome by the Policy makers. This would help reassure the west and build credibility.

Lets wait and watch to see if the Government goes for short term fixes or goes for an all out war to clean the system.