- By Vivek Kaul
Since the beginning of the year, the Chinese government has been trying to get the stock market to rally. Among other things the official Chinese media has been writing positive things about the stock market.
On April 21, 2015, the People's Daily, the mouthpiece of the Chinese Communist Party (which also runs the government) ran an online commentary advising people to invest in the stock market. This after the Shanghai Composite index had rallied by around 30% since the beginning of the year.
As Evan Osnos writes in The New Yorker: " Even though share prices had soared...this was "merely the start of a bull market," since blue-chip stocks remained "undervalued," the author, Wang Ruoyu, explained."
He went on to assuage any fear of the Chinese stock market being bubble, assuring readers that stock market gains would continue in the days to come due to the full "support from China's grand development strategy and economic reforms."
What this meant was that the Chinese government would continue to support the stock market and given that the investors had no reason to worry. Between April 21, 2015 and June 12, 2015, the Chinese stock market rallied a further 22.5%, closing at 5166.35 points on June 12. Since then the market has taken a beating and fallen by 26.3%.
It is but natural that a government which works towards driving up the stock market, will also prevent it from falling. In the aftermath of the fall, the Chinese government has tried to do various things.
Short-selling has been disallowed. Like is the case with the Life Insurance Corporation(LIC) in India, Chinese pension funds have pledged to buy more stocks. Further, initial public offerings have also been disallowed, so that the Chinese investors are forced to buy stocks that are already listed in the market.
Over and above this, investors who own more than 5% of a company's stock are not allowed to sell any of their holdings over the next six months. Further, many Chinese stocks have announced trading halts. Hence, in various ways the Chinese government has tried to bring down the total amount of selling that would have otherwise happened.
What this clearly tells us is that the Chinese government is trying everything to prevent the stock market from falling any further. It succeeded briefly with this strategy and the Shanghai Composite rallied by around 7% between July 9 and July 13, 2015. But it fell by 4.15% over the next two days.
The Chinese strategy is similar to something that Pakistan tried in 2008, after the start of the global financial crisis. As Albert Edwards of Societe Generale wrote in a recent research note: "Among other radical measures, China has allowed the mass suspension of shares to stop the ongoing market collapse. It should take a lesson from Pakistan. In 2008 a 'floor' was put under the Karachi SE100 to stop its collapse. Unsurprisingly when trading resumed, the slump continued apace. The episode left the authorities' reputation in tatter."
So what happened in Pakistan? As a 2012 news-report in the Pakistani newspaper Dawn points out: "In that fateful year, the Karachi stock market index of 100 shares had galloped to touch its all-time high level of 15,760 points on April 20, 2008. And then the stock prices collapsed with index plunging by almost 55 per cent or by 5,600 points in four months. As panic was thick in the air, an entirely insane act was performed. On August 20, 2008, a "floor" was fixed at the level of 9144 points below which the index was not allowed to fall."
This trapped investors who were looking to exit the stock market. This so called floor was maintained for 108 days and was lifted finally on December 14, 2008. Not surprisingly on that day the stock market fell by 4%. By the end of 15 sessions the stock market had crashed to 4782 points.
The point being that all the floor did was delay the crash. Also, this sort of manipulative manoeuvre had never been tried before in the history of stock markets. As Sim Cox of Emerging Markets Stock Fund (Hong Kong) told the Dawn: "I have gone through the record of stock exchanges and never since the oldest stock exchange in the world at Amsterdam was established in 1602, I could locate one example where a stock exchange had ever blocked the exit in violation of basic principles of free market mechanism."
The Chinese authorities can learn a thing or two from the Pakistani experience. The main learning is that when a government manipulates a stock market and prevents it from finding the right level, the bust that follows is always much bigger. As Edwards writes: "the reality of these things is that you can never control a bubble."
Further, the desperation doesn't show Chinese authorities in good light. As, the emerging market guru Mark Mobius puts it: "It suggests desperation ... It actually creates more fear because it shows that they've lost control."
Edwards agrees with Mobius: "The Chinese authorities including their central bank have now lost a huge amount of credibility with investors and bystanders alike. Unlike the western authorities whose reputation for economic management remains in tatters after presiding over the Global Financial Crisis (GFC) in 2008, the credibility of the Chinese authorities had remained high for their handling of the 2008 crisis."
To conclude, I hope the Indian regulators are following the situation in China closely, and picking up a few lessons to add to their kitty for the days to come. After all, in economics, very few situations can be tested out in lab settings.
Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.