Asia and Pacific

Chinese stock market losses dwarf Greek tragedy

Sunday July 12, 2015 Hugh Dixon

The Chinese government has over the last week gone all out in order to halt the falling prices in the Shanghai Composite Stock Exchange (SSE).   On the 9th July 2015, prices on the SSE have finally stopped falling, after they had dropped by 30 percent (or NZ$4.8 trillion) since June 12th 2015, for comparison Greece currently owes NZ$524 billion, while its GDP is NZ$351 billion.

 

Given the efforts by the Chinese Government the Shanghai Composite Stock Exchange (SSE) is unlikely to fall further.  With the stock market prices stabilising, the decline in stock prices already experienced is unlikely to affect Chinese consumption expenditure or Chinese business imports of New Zealand goods.  The SSE only has two percent of its total value of shares owned by foreign companies or individuals; the majority is owed by the Chinese public, the flow on effect of the downturn will be minimal on the international financial markets.

 

greece stock

 

This 30 percent fall has come on the back of a 150 percent increase in the SSE since June 2014.  The 150 percent increase seen in the SSE over the past year has come about for a combination of reasons, the first is that unlike the US where first day returns on new Initial Public Offers (IPOs) average 17 percent, in China the first day returns average 137 percent, which means investors are eager to invest in these IPOs.  The second reason is the Chinese government had been easing restrictions on margin trading, which have allowed more of the Chinese middle class to borrow money in order to invest in SSE share, this has seen the value of margin trading rise from 403 billion yuan to 2.2 trillion yuan (or NZ$525 billion).

 

In order to stop the drop in SSE prices, the Chinese Government has undertaken a large range of options, including:

  • halting hundreds of companies from trading their shares,
  • freezing new IPOs,
  • pushing stock brokers to buy falling stocks, and
  • offering more and easier financing to retail investors who dominate the SSE.

 

The efforts of the Chinese Government to halt the decline in the SSE is somewhat ironic given that it was a tightening of rules around margin trading, designed to slow the very rapid increase in the market since June 2014, that caused the SSE to go into decline in the first place.  Prior to the decline in the SSE the Chinese Government:

  • Raised the minimum amount of cash needed to undertake margin trading
  • Punished companies for failing to enforce margin trading rules
  • Banned brokers from using umbrella financial instruments to help clients get around cash limits on margin trading, such as wealth management product.
  • Limited the total amount of margin lending a broker could undertake

 

Combined these new rules and greater enforcement of existing rules, caused a panic amongst existing investors and stopped a large number of new investors investing in the market and therefore the market started to fall.  As a consequence of the initial fall many Chinese investors pulled out of the market to ensure they didn’t incur losses they couldn’t afford.

 

Given the SSE invests is largely made up of mum and dad investors or retail investors, rather than financial institutions and pension funds, like western stock markets.  The Chinese Government has been taking these steps to stop the SSE from crashing, as it could wipe out the life savings of millions of the Chinese middle class, upsetting the middle class and potentially causing political strife for China, hence its desire to head off the drop in the market before it gets worse.