Beijing must realise that intervening in the stock market can lead to moral hazard

PUBLISHED : Friday, 17 July, 2015, 1:44am
UPDATED : Friday, 17 July, 2015, 1:44am

When even the strong arm of the state proves inadequate to stem the bloodletting in the mainland's A-share market, it quickly turns into a fist. Following a slew of measures that failed to halt a stock market rout, Beijing has sent in the police to track down "suspected" market manipulators and "malicious short-sellers". That seems to have done the trick, for now. The market has stabilised in recent days, though the announcement of a 7 per cent quarterly GDP growth sent stocks tumbling by more than 3 per cent on Thursday, before recovering half a per cent yesterday.

In a market as tightly regulated and controlled as the mainland's stock exchanges, administrative intervention can prove effective in the short run. But over a longer time horizon, authorities will have to liberalise and open up by allowing market forces a freer rein, as President Xi Jinping has promised. Beijing's heavy-handed intervention shows the authorities were just as panicky as many retail investors. That's easy to understand, seeing how the key benchmarks plunged more than 32 per cent in less than a month since June.

That led to a series of official mishaps. The first was blaming "foreign influences" for the market collapse. In such a highly controlled capital market where foreign institutional investors are given only limited investment quotas, their influence is severely curtailed by design. If anything, the high volatility is partly the result of a market dominated by domestic retail investors, who account for 80 per cent of the turnover. Thankfully, official outlets have toned down their rhetoric about foreign influences.

Instead, Beijing now blames "malicious short-selling" for the market plunge. Short-selling by borrowing shares is a perfectly legitimate trading strategy. But in official usage, it has become a blanket phrase that includes spreading rumours, insider trading, share dumping and generally any market manipulation. No doubt manipulation and insider trading happened during the recent market turmoil. Authorities, including public security officials, must investigate and punish those responsible.

But the plunge itself was normal market behaviour. Officials must accept adverse market conditions if they are ever to liberalise the mainland's capital markets. They must not create a moral hazard whereby investors would expect an official rescue each time the market corrects itself.