Focus on long-term stock market stability needed
There have been calls from high-level government officials to boost the stock market in recent days and various measures have been taken, but the core issue is not to return to the kind of bull market that was seen in 2014 and early 2015.
Instead the key factor is finding out how to stabilize the market so that confidence in it can be rebuilt. Based on past experience, government polices to boost the market only have short-term effects. To ensure long-term stable growth in the Chinese stock market, systemic reform is imperative.
During the market crisis in 2015, after the Shanghai Composite Index dropped by 6.5 percent on May 28, the Xinhua News Agency called for stabilizing measures. But within one month, the index fell more than 9 percent.
In 2016, when the Shanghai Composite Index declined by 6.9 percent on January 4, the China Securities Regulatory Commission moved to support the market the very next day and this lifted the index. But a month later, the index was still 17 percent lower than the level on January 4.
It is very clear from these experiences that government policies only have short-term effects, and that long-term growth of the stock market requires more fundamental improvements.
Fast forward to today. Why is the Chinese stock market suffering continuing declines? What is the most pressing problem that needs to be addressed in order to restore confidence in the market?
First, the reasons behind the recent declines are very different from those in 2015 and 2016, but there are still connections.
In 2015, it was the excessive use of leverage by investors that triggered the market rout, which then worsened after brokers asked for more insurance money from investors. Following the stock plunge, regulators cracked down on fundraising channels that tended to lead to high leverage, including over-the-counter funding and umbrella trusts. But there was a problem that was left out of the crackdown efforts: share pledge financing.
It is common for Chinese companies to get share pledge loans from the banks or brokers. But such loans pose a huge risk for the stock market when the indexes are diving.
Moreover, although these high-risk financing tools were cleared, they added new problems, which in turn exacerbated the risks from these tools. And with the participation of securities firms, banks and trust funds, share pledge financing was repackaged in the form of high interest financial products in order to raise more funds. That made the risks much greater.
Currently, there are 3,548 stocks listed on the two exchanges in Shanghai and Shenzhen, and 2,163 of them have engaged in share pledge financing. The total number of shares involved in the financing has reached 637.3 billion, accounting for 9.94 percent of the total shares, with a value of about 4.44 trillion yuan ($644 billion). Among them, 982 stocks have fallen below the warning line.
This points to a dire situation. If stock prices continue to fall, there will be a liquidity crisis in the market, which could lead to further declines and even a financial crisis. What makes this worse is the fact that the lack of open and
transparent information about the risk of share pledge financing and the market makes it hard to judge the situation. So investors rely on certain activities in the market to make decisions, but this can cause uncertainty.
Share pledge financing also involves many institutions and many areas. The unknown risks make it more likely that investors will panic. This is the key reason for this year’s repeated market declines.
If regulators do not step in, there will be a bigger problem because the panic will trigger a new round of declines and cause greater trouble.
If the authorities do not institute systemic reforms in the Chinese stock market, it will not be easy to ensure longterm stable development.