China's stock market crisis also brings opportunity for more reforms

PUBLISHED : Tuesday, 07 July, 2015, 1:45am
UPDATED : Tuesday, 07 July, 2015, 1:45am

Beijing, as expected, has come to the rescue of the mainland stock market. Over the weekend, a slew of measures were introduced in a bid to halt a domestic market rout that has so far wiped out US$2.8 trillion in market capitalisation. The central government is trying to put a floor to the market slide. The trillion dollar question is: will the "Li Keqiang put" restore market confidence?

After the premier chaired the weekend State Council meeting that launched the sweeping response, the Shanghai and Shenzhen markets staged a brief rally yesterday amid a sea of red from collapsing global markets affected by the Greek debt crisis. It remains to be seen whether mainland market conditions will stabilise in the coming weeks and months, or whether more needs to be done. This is widely seen as a test of how well Li's economic team will handle the crisis.

Those measures included liquidity support for the state-owned margin lender China Securities Finance Corporation; setting up a 120 billion yuan (HK$150 billion) stability fund by the mainland's largest brokerages to prop up the market; and a pledge by mutual fund firms to inject capital into investment vehicles they manage.

Ultimately, restoring market confidence is the key. Excessive leverage has built up in the system. Margin financing provided to clients by brokerages on the mainland now stands at 2 trillion yuan with another 3 trillion lent through other unofficial channels. In a market where 80 per cent of stock turnover is driven by retail investors, the central government is naturally alarmed if ordinary people sustain heavy losses. After all, the leadership wants to develop the capital market into a new source of growth for the Chinese economy. The recent volatility has therefore been a challenge and a lesson for both leaders and investors alike.

Punters need to rein in excessive leverage - or borrowing on margins - as it multiplies losses as well as profits. Investment decisions are still based too much on government policies rather than economic fundamentals. That needs to change over time. The danger for regulators is that with too much state interference, recent gains in market liberalisation may be reversed. A right balance needs to be struck so that capital markets on the mainland may develop along a healthy path. The latest crisis has come at a staggering cost, but handled correctly, it may help bring along China's economic reform.