There has been more than a whiff of official desperation in the air over the last few days. With the Shanghai stock market down 29% from its mid-June high, Beijing stepped in over the weekend with a barrage of administrative measures intended to arrest the slide and prevent the ruin of millions of ordinary mainland investors. Its efforts to support share prices appear to have worked, at least for now. The benchmark Shanghai Composite index ended Monday up 2.4% from Friday’s close. But there is a deep contradiction at the heart of Beijing’s attempt to prop up China’s stock market, and not just because the central government is relying on measures that smack of official panic to restore investor confidence. In the longer run, Beijing’s intervention to push up prices is directly at odds with its broader policy aim of allowing market forces to drive China’s transition to a more productive, less managed economy.
The steps the authorities have taken over the last couple of weeks to bolster sentiment leave no doubt about the importance Beijing attaches to a strong stock market. Indeed, the bull market which pushed the Shanghai index up by 150% over the 12 months to mid-June, and drove some hot tech stocks up by 1,000% or more, was engineered by the government in the first place. By repeatedly exhorting savers to buy in, by relaxing the rules governing margin trading—when investors purchase stocks using borrowed money—and by cutting interest rates and injecting large quantities of cash into China’s financial system, Beijing inflated a stock market bubble into which legions of ordinary Chinese pumped their savings. But when confidence faltered, as confidence inevitably does in momentum-driven markets, it triggered a stampede for the exit which has seen some formerly hot stocks fall by more than 50%, wiping trillions of renminbi off the paper value of the market.
In response the authorities cut interest rates once again, injected yet more liquidity, announced the national pension fund would be allowed to buy stocks, and vowed retribution against rumour-mongers. When all those measures failed to halt the slump, Beijing deployed a whole new array of market-boosting weapons. Over the weekend, the government suspended new share issues, to prevent dilution and free up investor funds. The regulators pledged increased support to margin lenders. Central Huijin, a giant state investment fund, announced it was buying index-tracking funds. China’s 21 leading brokerage companies set up a RMB120bn fund to support prices, and promised not to sell stocks. And nearly 100 fund management companies pledged to buy the market.
Similar measures have been used at different times in the past, but the simultaneous roll-out of such a broad range of initiatives emphasizes the political store China’s leaders set by a buoyant stock market. That’s partly because the government, having inflated the bubble in the first place, is now anxious to preserve its own credibility among China’s millions of retail investors by preventing a deeper crash. And it is partly because rising equity prices are an important component of President Xi Jinping’s “China Dream” of turning the country into an acknowledged global economic super-power over the coming decades. The central government wants a sustained bull market in equities to smooth the transition to China’s next stage of economic development. It hopes rising stock prices will cushion the impact of the economy’s continuing downshift to a slower growth trajectory by generating a wealth effect to boost consumption. It also wants a strong stock market to encourage private investment and make it easier for Chinese companies to raise equity capital, reducing the economy’s reliance on debt. And it needs robust stock prices to ease the privatization of state assets, in order to create an efficient economy governed more by market forces and less by official diktat.
The trouble with Beijing’s price support operation is that if it fails, the damage to the government’s reputation will be even greater. Conversely, if it succeeds, Beijing’s blatant manipulation of the market will be a direct setback to the government’s ambition to move towards a liberalized financial system with robust—and largely independent—institutions, and an economy in which market forces play a more dominant role. In other words, in its desire to control the economy, Beijing is attempting to manipulate prices in order to promote market forces. That’s clearly self-defeating. There are limits of control.