Any capital outflow must not be allowed to hurt stock market

China’s stock market continued to tumble on Tuesday but, unlike other major indexes across the world, the fall was not triggered by the terrorist attack during an Ariana Grande concert at Manchester Arena in the United Kingdom on Monday. Instead, the weakening of the Chinese stock market in recent weeks is a reflection of the domestic market’s inherent problems and the unstable global macroeconomic and financial situation.

The benchmark Shanghai Composite Index dropped by a moderate 0.45 percent to hit 3061.95 on Tuesday, but most stocks slumped, with only a small number of big-cap stocks managing to rise. Since early April, the SCI has dropped 7 percent, with individual stocks slumping by much larger margins.

It is reasonable to attribute the fall of stocks to the economic slowdown and the tight regulation that China has imposed on the market to curb broad financial risks.

China achieved an impressive GDP growth of 6.9 percent in the first quarter of this year, higher than the 6.7 percent growth last year. But most analysts say the strong growth could gradually ease in the coming quarters given the stringent tightening of the real estate market.

The real estate sector and related industries have contributed to a significant part of China’s growth, but the exorbitantly high housing prices have compelled the government to impose strict restrictions on sales and raise the down payment for homebuyers in most major cities, which could slow the growth of the sector and thus the overall economy.

The monetary regulators, meanwhile, have started tightening liquidity by strengthening financial regulation, which, together with the government’s efforts to reduce overcapacity, is expected to further dampen economic activities. As a sign of the tightened monetary policy, China’s broad measure of money supply, or M2, increased only by 10.5 percent in April, the slowest pace since July last year.

China has set a GDP growth target at around 6.5 percent this year. Although some economists have forecast that it could achieve that target, others say growth may drop next year.

The movement of the stock market is not a reflection of the current economic situation, but of the future changes in the economic fundamentals. Even though the economy has stabilized, there is little possibility that it will pick up strongly this year or the next to achieve a GDP growth rate significantly higher than in previous years.

Apart from the economic downturn, the China Securities Regulatory Commission’s strict approach in recent months has also put pressure on the vitality of the stock market. The CSRC has rightly started to cleanse the market by putting behind bars stock dealers engaged in illegal activities, including those manipulating stock prices and giving false information. But such market regulations have also brought uncertainty to the market, prompting many investors to resort to panic selling of stocks.

Besides, the US’ interest rate hike early this year and expectations that it will continue to raise it further has created major fluctuations in the international financial market. Analysts generally agree that if the US continues to raise its interest rates, it will prompt more and more international capital to withdraw from emerging markets, including China, and flow into the US.

No one is sure about whether the US economy will improve to the extent of triggering more interest rate hikes, but the depreciation of the yuan against the US dollar and China’s declining foreign exchange reserves since the second half of last year show the serious impact of such interest rate hike expectations on the stability of the emerging market economies.

Given these factors, the Chinese authorities have attached more importance to taking pre-emptive measures to ward off financial risks and minimize the effect of any capital outflow. As a result, the CSRC has been very cautious in guiding the index lower so that a capital outflow does not have a serious impact on the domestic stock market.

... the CSRC has been very cautious in guiding the index lower so that a capital outflow does not have a serious impact on the domestic stock market.