Time to rebuild investor confidence in China market

August 08, 2015 08:00
China continues to rely on fixed-asset investment to drive the economy. Growth in fixed-asset investment is nearly 30 percent. Photo: AFR

The International Monetary Fund has voiced concern about China’s recent stock market rescue measures.

But not too long ago, Hong Kong famously intervened in the stock market amid extreme turmoil. 

The Hong Kong government used its foreign exchange reserves to stem a market slide during the 1998 Asian financial crisis.

The financial storm, which started in late 1997, blew away our defenses as global speculators led by George Soros targeted the financial market, short selling Hong Kong shares, stock index futures and the Hong Kong dollar.

The Hong Kong Monetary Authority was forced to sell US dollars and buy Hong Kong dollars to protect the local currency.

Earlier, Thailand failed to defend the baht, igniting the Asian financial crisis.

The Hong Kong government was determined to protect the currency peg to the US dollar, so on Aug. 15, 1998, it raised overnight interest rates from 9 percent to nearly 300 percent.

These measures managed to stabilize the foreign exchange rate of the Hong Kong unit.

However, the Hang Seng Index subsequently slumped more than 25 percent in late October that year and investors lost more HK$700 billion (US$90.3 billion).

The market tumbled 10.4 percent on Oct. 23 alone.

The Hong Kong government quickly moved to ban short-selling and reduce the settlement cycle for stocks and futures from 14 days to two days.

Also, it pumped liquidity into the banking system to cushion the financial shock.

These moves are quite similar to those in the United States and Britain during the 2008 global financial crisis. 

Britain's Financial Services Authority and the Securities and Exchange Commission in the US both halted short-selling of financial stocks until market confidence returned.

Hong Kong succeeded in defeating global speculators but its reputation was somewhat damaged as global financial institutions criticized the government intervention.

In hindsight, the criticism was overdone.

Old reliable

China continues to rely on fixed-asset investment to drive the economy.

Growth in fixed-asset investment is nearly 30 percent annually. Consumption is growing at single digits while export growth has stalled.

It will be quite difficult to maintain a growth rate above 7 percent under the circumstances.

In June, MSCI delayed the inclusion of A shares in its emerging market index.

I’m concerned that A shares will have a reduced weighting in the index as a result the market rescue measures.

The index compiler is likely to fret over Beijing’s massive market intervention.

In addition, the mainland equity market has yet to fully reflect real economic growth.

China is already the world’s second largest equity market but the MSCI weighing of A shares will depend on the confidence of foreign investors in the China market.

The key challenge for President Xi Jinping and Premier Li Keqiang is to restore market confidence and push mainland retail investors and officials to recognize the essence of the stock market.

The government should establish a credible market supervision system and stop treating the stock market as a casino.

This article appeared in the Hong Kong Economic Journal on Aug. 4.

Translation by Julie Zhu

[Chinese version中文版]

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adjunct professor in the Department of Finance at HKUST Business School