The Shanghai Composite Index recovered from a three-day rout, rising 3.5% on Wednesday on hopes the government will continue to prop up the market.
Beijing again promised support for Chinese shares to lure investors back in the Shanghai stock market after the index suffered its worst one-day fall in eight years early this week.
But market analyts are convinced new efforts at a market rescue can potentially be a slippery slope. Can China be thinking through a clear exit plan?
Many analysts believe authorities should let the market function independently. Rather than throwing money at the problem, the government is urged instead to focus on systemically important financial institutions.
China Securities Finance (CSF), the state-owned margin financing entity, is estimated to hold 1.58 trillion renminbi in funds. It has invested at least 860 billion renminbi (US$138 billion) in Chinese stocks to try to prevent fluctuations in the market. These cash infusions are proving insufficient still, to halt volatility in the market.
The benchmark Shanghai composite index on Monday plummeted by 8.5%, the biggest one-day fall since 2007 amid worries over the Chinese economy following weak economic data. Selling ensued and further extended losses yesterday.
A late Monday night statement from the central bank promised to maintain monetary policy stability, followed by the People's Bank of China announcing on Tuesday that it would inject 50 billion yuan ($8.05 billion) into money markets.
No clear exit in sight
Beijing has not revealed yet a plan on how to exit stock positions without creating significant market volatility, Christopher Balding, an associate professor at Peking University HSBC Business School, says in a phone interview with The Asset. “They might have to wait six to 18 months to sell the shares when the market recovers.”
What makes things so difficult for the Chinese government is the fact that they bought the shares at “nearly top of the market”, says Balding. Unlike in measures taken by other central banks, they offered help to the market during times of stress when stocks were trading at distressed prices.
Le Xia (夏乐), chief economist for Asia at BBVA Research tells The Asset in an interview that China’s situation is different from Hong Kong’s back in 1998 when the city’s stock market was attacked by foreign short-sellers. It also presents a stark difference for the rescue efforts of the US central bank in reviving its economy in 2008.
The US government didn’t buy the subprime assets, but bought big financial institutions to maintain the stability of its financial system, Xia says. “Buying equities from the stock market directly is not a market-driven approach,” he adds.
Instead of maintaining the stock market index level, the government should closely watch and protect the balance sheets of systemically important financial institutions such as banks, brokers and trust companies to prevent contagion of the crisis, according to Xia.
Xia also believes the withdrawal of massive amounts of money from the market is unlikely to happen within one or two years. One possible scenario is that the market gradually goes up and the government can sell the shares.
Another scenario is that the government may transfer parts of the stakes of state-owned enterprises (SOE) to private owners amid the SOE reform that is ongoing in the country. But that process may take several stages, starting with the People’s Bank of China or Ministry of Finance buying the shares from CSF first, Xia says.
The shares may also be transferred to the country’s pension funds, not through buying and selling, but transferring the shares for free in a bid to beef up the asset holdings of the pension funds, Xia adds. The government has recently proposed allowing the country’s pension funds to invest up to 30% of their assets in the equity market to improve returns on investment.
Shares trade halted
China recently halted the trading of shares of several companies, which Balding thinks is causing the market more harm than good. “Most institutional investors are very used to swinging share prices. By freezing the market, things could get worse.”
Many of these firms have loans based on the value of their shares, once trading is resumed and if the price goes down, banks would demand additional collaterals. That poses high risks to the firms and the market as a whole, according to Balding.
The government should re-establish market confidence in A shares – a marketplace where investors can come and trade their shares independently from the government, Balding says.
