Market rout will strengthen China's resolve to implement long awaited reform

Fred Hu believes market turbulence, painful as it is, will spur the fundamental reforms China needs

Reading Time:5 minutes

The market gyrations have sent a loud and clear message to Chinese policymakers. Bold reforms can restore investor confidence.

Published: 5:15pm, 27 Aug 2015Updated: 3:29pm, 13 Jul 2018

The rout in China's stock markets has sent shockwaves across the world, dragging global equities, currencies, bonds and commodities into the worst tailspin since 2008. Both domestic and international investors seemed to have lost faith in China's once-fabled ability to manage its economy, hence the deepening gloom and spreading panic everywhere. While there are very valid concerns about China's economy and financial system, market reactions are vastly exaggerated.

To start with, China's falling domestic equities do not necessarily herald a sharp contraction in its broader economy. Historically, the country's immature and extremely volatile stock market has been a poor predictor of gross domestic product growth. With retail trading dominating the market place, share prices are mostly driven by short-term sentiments, not by any rational expectations of economic fundamentals.

Since mid-2014, the Chinese equity market had been gripped by sudden spikes of speculative frenzies, in part fanned by the official party media, and started a stunning rally. As valuation quickly soared to astronomical levels, a sharp correction just seemed inevitable. That is exactly what has happened over the past few months.

With Shanghai now down by more than 42 per cent from its peak, the current stock valuation has factored in most of the bad news - manufacturing malaise, weakening exports and capital outflows. The risks of further sharp declines in China equities appear limited.

Unfortunately, the Chinese authorities' market interventions have done more harm than good.

Perhaps the most powerful weapon of all in China's policy arsenal is the opportunity to pursue sweeping economic reforms

Far from stabilising the markets, massive stock-buying by state-owned institutions has distorted the functioning of the stock market, caused widespread confusion and aggravated the risk of moral hazard, further undermining investor confidence at home and abroad. The unprecedented stock market interventions, many pundits speculate, must have revealed the Chinese government's deep worries about the rapid deterioration of the underlying economy. Yet the Chinese stock market, though second only to the US by market capitalisation, remains a sideshow as far as China's Main Street is concerned.