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30 Sep 2015


Chinese manufacturing and investment indicators have been contracting for some time as the world’s second largest economy struggles to reduce its reliance on fixed investment growth. A stock market rout in the second quarter has put the country’s economic and financial performance in the spotlight. BRIAN ARCESE looks at the development of the Shanghai bourse and its boom-bust cycle this year.

Relative to developed and other emerging markets, Chinese economic growth has been unrivalled for the last two decades. The growth rate after the global financial crisis has been equally impressive, averaging almost 8% per year since 2011. Fixed asset investment growth underpinning the urbanisation of China’s massive rural population has been the driving force behind the growth.

Commodities entered a decade-long bull market as China became the major buyer of most industrial commodities. Cheap, abundant labour infiltrated the world through “Made in China” labels, to the detriment of manufacturers elsewhere in the world. Despite, or perhaps because of, its central planning and lack of free market policies, China developed to overtake Japan as the world’s second largest economy.

The Shanghai Stock Exchange, one of two on the mainland, is among the top 10 in the world by market capitalisation. However, due to restrictive capital controls it is not fully accessible to foreign investors. In late 2014, the Shanghai–Hong Kong Stock Connect was introduced to link these two giant Asian bourses, allowing investors in each market to trade shares of the other using their local brokers and settlement houses.

The implementation of this cross-boundary channel was the catalyst for rising share prices on the Shanghai exchange, which is dominated by almost 100 million retail investors. Amid accommodative monetary policy and the urging of state-controlled media, investors embarked on a credit-fuelled stock market binge. In essence, investors used borrowed money to buy listed shares and to invest in initial public offerings (IPOs) at heavily inflated prices. There are many anecdotes of taxi drivers and low income earners with hundreds of thousands of renminbi invested in listed shares, mostly with money they did not have.

This worked well for some time, as Chinese stocks made a 150% run from July 2014 to their peak on 12 June 2015. A thriving share market was seen as an endorsement of President Xi Jingping’s economic policy to steer the country away from bank lending and to develop a diversified financial sector. Accordingly, the state often encouraged investment while denying the existence of a stock market bubble despite share prices expanding significantly faster than economic and earnings growth.

At the time of writing, the index has fallen 34% from its peak, with significant intra-period volatility. The cause of the collapse is uncertain, but the catalyst may be MSCI’s announcement that Chinese mainland shares would not qualify for inclusion in the main MSCI Emerging Market Index. As prices fell, investors faced margin calls on their heavily geared positions. Those with insufficient cash reserves were forced to sell shares in the market, causing market panic.

The market rout has been an undeniable embarrassment for the Chinese authorities, which intervened in an attempt to reflate the bubble it helped to create. Measures adopted included a trading halt, suspension of IPOs, relaxation of rules on margin loans and collateral, sales bans on major shareholders, prohibitions on short selling in certain circumstances and the provision of cash to brokerages to buy shares. Some or all of these measures appear to have stabilised the market. However, the longer term damage caused by government intervention is unknown.


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