25 October 2016
Despite the recent rout in the mainland stock market, many individual investors retain their faith in the ability of the country's top leaders to engineer a favorable outcome. Photo: Xinhua
Despite the recent rout in the mainland stock market, many individual investors retain their faith in the ability of the country's top leaders to engineer a favorable outcome. Photo: Xinhua

How Beijing the savior is distorting the mainland market

Few will assume that official statistics, especially economic data, from the Chinese authorities are reliable in toto.

This common skepticism derives from the opaque way the communist cadres conduct their business and the imperative that the wishes of senior officials must be obeyed.

This year’s target for growth in gross domestic product, for instance, has been set at 7 percent, and so the figure that will emerge at the end of the year can only be exactly the same.

Even though Premier Li Keqiang, a modest gentleman, has left some room for variation with his prediction of 7-percent-or-so growth, the official growth rate is already set in stone: it must be around 7 percent with absolutely no major discrepancy, no question.

The economy is the sum of human activities which can hardly be predicted.

The Chinese government will be the envy of the rest of the world if it has mastered the secret to forecasting economic behavior with such precision.

The fact is that mainland statisticians won’t hesitate to produce or inflate figures to pander to their bosses.

But at least in one area, even these all-powerful Chinese statisticians find they can do nothing to falsify the numbers: the stock market.

Beijing has been constantly discomfited by these figures that it cannot manipulate.

All market transactions are trackable, and the formulas for calculating indexes and the respective weightings of stocks are known to all traders, although it is not impossible that the government may explore ways to lift or drag down the indexes as it likes.

But before that happens, Beijing has to resort to blatant, all-out rescue maneuvers.

And as the Financial Times noted earlier this month, if the stock market continues to plunge in spite of the government’s utmost efforts, then the illusion of omnipotence that Beijing enjoys among the people will surely suffer.

It’s safe to conclude that, in an attempt to defend Beijing’s authority, Li will roll out follow-up measures if the market is still ailing.

The bull run preceding the recent rout pushed up the Shanghai and Shenzhen markets by almost 150 percent since November.

Both markets then suffered a sharp dive of about 30 percent.

Yet most investors can bear this reversal, considering the extent of the previous rally.

People may have lost part of their quick profits, but their capital should remain unscathed.

Obviously, however, those who have leveraged large sums for speculation may find themselves in dire straits.

With its propaganda machinery, Beijing spared no effort propping up market sentiment during the rally.

Some individual investors — subscribing to the notion that Beijing would never let the market turn bearish — jumped onto the bandwagon, betting money they did not own.

Mainland media reports say that up to 2 trillion yuan (US$320 billion) worth of funds have entered the market.

Much of that came from margin financing as investors borrowed money from brokerages using stocks as collateral.

Along with other, shady capital, 10-20 percent of the funds circulating in the stock market likely involves some sort of leverage, and this estimate is on the conservative side.

Worse still, not a few of the first-time stock market investors are addicted to leverage, with a gearing ratio of nine times or more.

Against that backdrop, whenever there is a major slump, Beijing will have to rush to the rescue for the sake of social stability.

Given the political reality in the mainland, the argument that Beijing is confident about and capable of coping with all sorts of challenges is not at all overstated.

Thanks to China’s overall national strength, Beijing is well equipped to pour resources into maintaining stability even if the rescue operation will incur hefty costs.

It would be humiliating to the assertive central government at the wheel of the world’s No. 2 economy if it fails to get the job done in taming and rekindling the market.

What will the Chinese stock market look like after Beijing’s barely disguised meddling?

The conventional wisdom is that the stock market is the child of capitalism and entails a level playing field.

Fair and open regulation is a prerequisite for it to function as a fundraising platform for companies.

Now with the introduction of Chinese characteristics like slack regulation, hoaxes and shenanigans as well as the illusion that the market can only soar further, the mainland market runs opposite to these principles.

While it appears that the indexes will rebound at Beijing’s command, international players may well flinch at the risks and uncertainty, and so will domestic investors.

The reason is plain: only those who have access to or can create “insider information” can make the most of the distorted market.

Beijing’s ambition to build its own indigenous international financial center is now a pipe dream.

I wonder if top policymakers may not be too much bothered by these consequences, as they believe the “one belt, one road” strategy and the Asian Infrastructure Investment Bank will help offset the impact of stock market turmoil and fuel the nation’s financial sector.

However, China will be hungry for funds as it grows its economy even further, and a stock market that fails to win the trust of investors will be a huge drag on its ambitions.

China’s overall prospects do look rosy, and such optimism is the catalyst for the euphoria throughout the past nine months.

The number of individual investors, the majority of whom opened their stock accounts within recent months, has reportedly surpassed the number of members of the Communist Party of China, which stood at 87.79 million at the end of last month.

Perhaps the premier should be more careful with what he says.

One word he should have avoided using is “rescue”.

The right thing to do is to regulate trading, step up law enforcement and educate individual investors.

That is the only way the mainland stock market can benefit the real economy as it should.

This article appeared in the Hong Kong Economic Journal on July 8.

Translation by Frank Chen

[Chinese version 中文版]

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A famous Hong Kong writer; founder of the Hong Kong Economic Journal

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