China's stock market intervention: Are government efforts hindering recovery?

As China’s stocks continue to tumble, the country’s authorities have alternated between implementing far-reaching measures to keep the market afloat to seeking out scapegoats for why their attempts aren’t working.

On Monday, the Chinese stock market slid around 1 percent, a moderate drop compared to the 8 percent decline of the previous week. But analysts are not seeing a sustained upturn happening anytime soon and government officials and market watchers are struggling to pinpoint exactly what went wrong and what they can do about it. While Chinese authorities have pointed a finger at foreign investors, launching an investigation into whether algorithmic traders are influencing prices by offering and retracting bids at whim, many Western analysts say that the Chinese government’s heavy-handed intervention is to blame for hindering the market’s recovery.

 “The biggest drop in Chinese stocks in eight years Monday is another sign that Beijing’s efforts to prop up prices have failed," wrote Burton Malkiel for the Wall Street Journal last week. "Moreover, the interventions themselves have made China’s equity markets more volatile and damaged their credibility in the long run."

The Chinese stock market reached its peak in mid-June when the bull-run that began in the summer of 2014 came to an abrupt halt. Since then, the stock market has continued to plunge as the government pulled out all the stops to prop it up. Over the last few months, Beijing eased borrowing measures to encourage investors to buy back stocks and permitted Chinese speculators to use their homes as collateral for borrowing to buy more. Meanwhile, due to an exchange rule that imposes a daily up and down limit of 10 percent for stocks, trading was suspended for over half of all shares.  Numerous funds were also created to assist some of the country’s largest brokerage firms to buy stock funds themselves and the central bank cut interest rates to record lows. But perhaps the most criticized measure was the government’s decision to prohibit major shareholders from selling and to ban short sales and new initial public offerings.

Now analysts say that these measures will have long-term repercussions by damaging investors’ faith in the market and encumbering much-needed market reforms.

“All of these interventions show that the government is willing to jump in with a bunch of ad hoc measures, so that could make people think that the government is willing to prop things up,” says David Dollar, senior fellow with the Foreign Policy and Global Economy and Development programs at the Brookings Institute.

“But it hasn’t worked very well. So for many investors, it should make them nervous that it’s not really a fair stock market, that it’s something where the government might come in and try to push prices one way or the other. And that undermines a general sense that the stock market is the right place to invest,” he concludes.

Writing for Forbes, Junheng Li, an expert on China’s economy, agrees that the measures will drive away investors.

“Many Chinese and foreign investors will hesitate to go back into a market where you may not be able to get out when you want to (even when the daily 10% limit on individual stock price declines has not been reached), where you can be forced to buy more stock than you want to and where the authorities can compel private participants to put their money at risk by having to create a stabilization fund,” Ms. Li wrote.  

And Heather Long, who compared China’s stock market woes to the United States’ 1929 “Black Thursday” in a piece for CNN Money, agrees that the moves do little to inspire confidence.

“Part of the problem is that when there's a big intervention like what the bankers tried to do in 1929 or what China's government is doing now, it's akin to several fire engines showing up with their lights and sirens blaring. It looks bad to outsiders (or, in this case, to investors). After checking out what's going on, they typically want to get away,” Ms. Long wrote.

Now many investors say they fear the recent policy changes could jeopardize some of the market reforms many had expected would bolster the Chinese economy in the near future.  

“The key question being asked by investors in Chinese stocks – especially those offshore – right now seems to be whether the administrative intervention will impact critically needed market reforms,” Li wrote, adding that most of the investors she has spoken with say they believe it will.

And Mr. Dollar agrees that the current situation could hinder the removal of some red tape for companies that planned to enter the stock market.

“They had been heading towards a very important reform. Up until now, to be listed on the stock market, you need to get all kinds of government approvals and it was quite bureaucratic and it’s rumored to be pretty corrupt. But they were moving more towards a system like the US, where if you meet certain standards, like three years of audited statements and you’ve been profitable, then you can make your own decisions, you can go public or not go public,” explains Dollar. “I’m pretty sure this whole experience is going to slow down the reform of China’s stock market in that direction.”

“That would be a healthy direction in the long run because it would allow a lot of new, mostly private companies to come into the market to create a more diversified stock market that has more of a real connection to the real economy,” he continues.

For now, however, analysts are not predicting that the stock market crash, which many say is really just the correction of 2014’s spike, will have a serious impact on the rest of the economy.

“The country’s stock market plays a smaller role in its economy than the U.S. stock market does in ours and has fewer linkages to the rest of the economy,” Bill Adams, PNC Financial’s senior international economist in Pittsburgh, told Forbes.

Still, the real danger lies in the fact that the government’s failure to save the stock market could undermine people’s confidence, says Dollar.

“If people start to feel that this is not such a competent group of technocrats overall, then that can affect their sentiment, their confidence. And that can start to affect real investment and real consumption and can contribute to further slow-down.”