China’s unprecedented stock market crash in the recent weeks shows the dangers of investing in a market which is heavily manipulated by the government, lacks transparency and fundamentals are unknown.
The government media and machinery worked tirelessly to promote bullish behaviour by openly encouraging retail investors to buy more shares. And people did invest as if the bull run will never end. The government campaign resulted in 40 million new stock accounts between June 2014 and June 2015 and the Shanghai Composite Index went up by 150 per cent in the same period. When the market crashed, the government tried to manipulate the market again by pumping more than $200 billion in stock markets to stop the rout only to realise it can’t possibly stop the free fall. The government is now left red faced and embarrassed.
China’s leaders have viewed the rising stock market, erroneously, as a sign of the country’s economic might and a necessary manifestation of their growing global influence. A falling stock market therefore is perceived a sign of political weakness. This explains why the government panicked over the crash and started an extraordinary rescue operation. Short selling was capped. Pension funds were ordered to buy more stocks. New Initial Public Offerings were suspended to limit the supply of shares and the central bank created funds for brokers to buy shares. Companies major shareholders were barred from selling their shares for six month and companies were ordered to buy their own shares. Nothing worked.
There are some intriguing facts. Even though the stock market lost almost one third of its value over the weeks, it was still 80 per cent higher than the last year. Foreign investors do not account for significant share of stock trading. Less than 5 per cent local household assets are invested in stock market. State-owned companies dominate the two main stock exchanges- Shanghai Stock Exchange and the Shenzhen Stock Exchange. State-owned companies offer only a tiny part of their shares for trading to maintain their control over the company. In other words, these companies don’t really rely on stock markets for raising capital. In summary, stock markets do not play a significant role in China’s economy. It’s actually the politics that believes that booming stock markets reflect the government’s success in reforms and a fall erodes the government leaders credibility.
Governments everywhere, particularly in developed countries, try to prop up stock markets by intervening when they have to. But in their case, the stock markets account for more than 100 per cent of their GDP and the stakes are high. The way the Chinese government has intervened is more than just business.
It’s this sensitivity which led to the arrest of journalist Wang Xiaolu who worked for Caijing magazine and wrote in an article that the government was going to end interventions in the stock market. He was promptly arrested saying he “caused panic and disorder at stock market, seriously undermined the market confidence and inflicted huge losses on the country and investors for the sake of sensationalism.” His video confessions were aired on the state-owned TV channel CCTV. He is seen apologising for his news story in the video.
The authorities have warned other journalists and media outlets not to give too much coverage to stock market problems. Dozens of other people have been arrested in connection with the stock market crash facing accusations of insider trading, malicious short selling and spreading online rumours about stock markets.
The journalist’s arrest has turned the stock market crash story into a human rights and media freedom story. Media rights and human rights groups, within and outside China, have openly criticized the government move.
The key question is this: will the government slow down the market reforms after failing to control the stock market crash and go back to the tight control over the markets? What incentive it now has to reform the markets to let them function on economic fundamentals and transparency instead of driving through propaganda? The coming months will be crucial to watch.
This article, written by me, originally appeared in Ethical Corporation magazine, Sept 2015 issue.