Panic in China collapses its shares


In a conclave in late 2013 the Communist Party declared that it would let market forces play a "decisive role" in allocating resources. It seems that the play of interventionism from which China seems not to have let go has been brought before the China Composite Index a third of its value in the last month.

In this sense, China launched a plan of economic and social reforms never seen before, breaking with the past. These reforms consisted of liberalizing the markets:

  • Give a greater role to private companies.
  • Soften the one-child policy. Those couples in which the father or mother is an only child may have two children.
  • The prices of fuel, electricity and other services would be decided by the market.
  • Greater openness to the banking sector, allowing private capital to establish small and medium banks.
  • Reduce crimes that are the death penalty.

After two years, hope for economic reform in China appears to be falling apart, a panic response in stocks heralds that a full-blown bubble has formed. These hopes have dealt a severe blow to the Chinese stock market. In fact, 90% of a total of 2,774 shares have been suspended from trading or interrupted in recent weeks - when a share or an index in a market experiences both very sharp rises and falls, it is suspended during its listing for a period of time- .

Shares have lost a third of their value in the last month, dramatically reducing the country's wealth - an estimated $ 3.5 trillion, more than the full value of the Indian stock market. Remember that in China small savers bought shares even asking for loans, that is, most individuals owned shares and it was normal because they saw that in a bull market they could always get returns well above those we are used to.

The Chinese government is not really concerned about these falls in share prices, but rather how to stop this sell-off. This chaos in the market is the first economic blemish of the Chinese leaders, Xi Jinping and Li Keqiang.

The first mistake, is to think that the market crash portends an economic collapse, it seems highly unlikely. It's true that the stock market has shrunk by a third in a couple of weeks, but it's only back to March levels; it's still up 75% over the last year.

China continues to be lost in the drama that the stock market continues to play a small role in China. The value of free float of the Chinese market - the amount of shares that companies have in the market to be traded - is only one third of the Gross Domestic Product - GDP, compared to more than 100% in developed economies.

As we mentioned a few lines above, many shares were bought with debt, approximately 1.5% of the total assets of the banking system have been bought on credit, so we can say that this financing does not have a great weight in the systemic risk.

The economy is solid. With growth, although the slowdown, has stabilized. The real estate market is accelerating. Money market interest rates are low and stable, suggesting that banks are, too.

The problem then we can say that the two fundamental causes of this instability have their origin in the structure of the markets and the fragile reforms developed two years ago in China.

However, from mid-2014 to early June, business creation has tripled thanks to the momentum developed by Chinext. There is still a long way to go in terms of ultra-regulated IPOs, there is great interventionism in terms of initial public offerings, deciding the moment of exit and its price. Due to the delay by the government in approving new IPOs, many of them could not become the target of many investors who were pumping stocks up with their savings. Before long, the Price to Earnings Ratio (PER-) on ChiNext had hit 147, putting it in the same league as NASDAQ during the dot-com era.

On the other hand, China's financial system also helped inflate the bubble by pumping money into the stock market.

It is not just the motive that is unreliable; the nature of the intervention is also reckless:

  • Regulators plugged short selling.
  • The central bank cut interest rates to encourage buying shares
  • The pension funds pledged to buy more shares.
  • The government suspended initial public offerings.
  • A fund was created to buy stocks, backed by cash from the central bank.

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