Event

The bubble has burst on Shanghai and Shenzhen stock markets. After having soared by over 150% in one year, indices plummeted by 30% in a few weeks, a record in this century. Equity markets rebounded thanks to a range of temporary state measures including tightened rules on short selling and internet financing, suspension of new IPOs, prohibition for major shareholders from selling shares whereas the government has injected hundreds of RMB billions as liquidity support. However, volatility remains high, pointing to difficulties to stabilise markets and prevent panic.

Impact on country risk

Market correction is healthy as the fast increase was irrational in the weaker economic context. Ironically, the Chinese authorities tend to bear responsibility for having fuelled this bubble by stimulating private borrowing via cuts in bank reserve requirements and interest rates, and by investing money on stock markets (rather than on a landing property market) to support economic activity. Convinced of the state support, small private retailers put more money into equities. Now, the government’s rare failure to stabilise markets has eroded its credibility which is unwelcome in a time of continued economic slowdown that might in addition be underestimated by the authorities. Besides, with shares largely owned by retail investors, consumer confidence could be affected – even though this risk is mitigated by a high savings rate and a low share of household revenues being invested in equities – and form a negative spillover to the real economy. This is not what Beijing aims for given its wish to see consumption become a key engine of a rebalanced economy. Therefore, Beijing could once again temporarily support growth – and maintain internal stability – by stimulating exports notably through a depreciating RMB. The recent announcement of a possible widening of the RMB-dollar trading band would confirm this.

The government’s latest interventions raise questions about the reform process and the goal of giving a more decisive role to market forces. While the state is likely to remain a major economic player, liberalisation of the capital account and financial markets should nevertheless continue, possibly at a slower pace, as a means to contribute to China’s (and the RMB’s) financial modernisation and promotion on the international financial stage while pursuing the country’s economic transition. It is to hope that Beijing will learn that market manipulations harm market efficiency and feed a costly vicious circle rather than constituting a lasting solution. Meanwhile, persisting uncertainty maintains risks to the macroeconomic outlook and financial stability. Still, all in all, those risks are mitigated by the state’s determination to use its ample financial means to avoid a hard landing by a financial system dominated by big and solid public banks, and by limited corporate speculation on stock markets.

Analyst: Raphaël Cecchi, r.cecchi@credendogroup.com