The recent A-share market rout resulted from the tightening of shadow banking and margin financing. The move has accelerated the velocity of the stock market movement. However, any non-market intervention aimed at restoring investor confidence may not work in the long run.
Mainland authorities have unveiled support measures to arrest the market slump, including halting new initial public offerings and pressing pension funds to invest in stocks. The moves have not only created a moral hazard but will also have diminishing impact.
Instead, authorities should let market forces play a bigger role in pricing assets, and introduce long-term foreign investors to dilute the dominance of the market by retail investors. It should also pave the way for domestic pension funds and other institutional investors to invest in the stock market.
IPO is one of the main forces that have accelerated the market slide. The government had intended to speed up IPO approvals to open up direct financing channels for corporates, in order to reduce their financing costs and end their long-time heavy dependence on bank loans.
Excessive reliance on bank financing had resulted in high M2 growth rates over the last decade. On the other hand, the bullish market sentiment has boosted the number and pace of new listings flooding into the market. As such, the suspension of 28 IPO deals may help mitigate the downward pressure.
Frankly speaking, the mainland stock market lacks quality institutional investors. As a result, the market focuses on short-term speculation. It has failed to price trading assets properly. Market rumors have much greater impact on prices in China than in mature markets.
Looking at US market, the Dow Jones has nearly doubled to 18,000 points from around 9,000 points in early 2009. The market also had its ups and downs. However, as institutional investors dominate US market, some stocks could gradually recoup 70 to 80 percent of their losses. A market led by institutional investors is more resilient to market shocks and more sensible.
Chinese retail investors are more vulnerable to this kind of market rout. Authorities should therefore step up efforts in attracting more institutional investors.
The market meltdown could also take a toll on Beijing’s efforts to internationalize its currency. It remains uncertain whether capital account liberalization can be achieved this year.
China’s central bank should focus on stimulating real economic growth in order to offset the impact of the stock market slump. The central bank should further loosen monetary policy to reduce financing costs and provide funding for corporates.
The intervention measures may create moral hazards for market participants. That could distort market forces and hamper the long-term development of a healthy and effective market.
Apart from bailing out the stock market, mainland authorities should pursue structural reforms.
This article appeared in the Hong Kong Economic Journal on July 7.
Translation by Julie Zhu
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