Summary of Chinese Stock market crash Introduction The aim of this article is to explain the reason for Chinese stock market meltdown and examine the regulatory strategies government issued to relief the market. Section I discusses the background of the Chinese stock market. In section II, I will explain the whole story of this market meltdown. Section III examines the regulatory strategies and talks about possible influences. In the section IV, I will propose the suggestions about how to conduct an appropriate strategy to save the market.
Section I: The Nature of Chinese Stock Market The Chinese stock market is unique in that it is moved more by individual retail investors rather financial institution. China uses price limits in the stock market every day which cannot fall by 10% in a day. In China at the start of the year, the stock market suffered a decline in index by 7%. There are investors who determine market prices and they are marginal. The marginal investors who can be individual investors are speculative and usually misinformed. With the lack of knowledge, individual retail investors’ behavior is easily to increase volatility of the stock market.
Section II: The Whole Story of Meltdown In the past 6 months of 2015, the Shanghai Exchange index soared and reached 4,000 points, remarking the bull market in China. The people daily marks that relying on the economic transformations and development strategies, this rise is different than that in 2007 (people daily 2015). Namely, they attribute the bull market to the economic transformations and development strategies rather than to the bubbles. Moreover, according to the CSRC, macroeconomic stability and low cost of financing also account for the bull market in China (finance QQ). Even though the government thought that the stock market looked to further increase, the crash still hit the market.
The meltdown, which many analysts deemed inevitable, began with a peak on June 12th, then a sharp decreasing marks the sign of this crash. The general causes behind this crash are week economic growth, currency devaluation, and the failure of a series of government interventions (Economist paragraph 3).
Starting from 2014, 150% increases on the Shanghai Exchange index largely depended on margin trading. In more detail, as Central bank loosened monetary policy, Chinese individual investors were encouraged to borrow money from a broker to buy securities.
As the demand of equities increases, the prices of equities also increases. Therefore, margin trading is believed to be a dig drive for the rise in Shanghai Composite index between 2014 and June 2015 (WSJ).
Behind this rise, the Chinese version of quantitative easing (increasing leverage ratio of margin trading and cutting interest rate) also inflates the stock market bubble. (左怡帆 2016). With the encourage of government and support of relaxing margin trading leverage ratio, investors quickly bid up stock valuations and create the bubble.
Notably, the margin trading ratio stood at 1:7 for many investors at the beginning of the bull market. However, the falling prices in the market led to a weaker position and as a consequence, margin calls increased tremendously in the wake of the crash.
Research indicates that some margin ratios fell to more than 1:20 indicating the extent of losses sustained by the individual investors in the market (Hunter, 2014). Regarding the Chinese stock market, the fortune of individual investors could be putting in an unsupervised portfolio.
A negative impact occurs once the market index went down due to the covenant-lite financing for investors and lack of control during the process. With such a high margin trading leverage ratio in Chinese Stock market, people can borrow 7 times money that in the account from the broker.
Additionally, everybody in China choose to jump into it and it cause other markets such as, real estate, manufacturing, are lack of liquidity which could also make a huge impact to Chinese economy.
Therefore, the government starts to regulate the amount of money that individual can finance with broker, requiring broker to immediately issue warnings regarding the under-margin situation of any account and offset all positions within delinquent customer accounts if the account doesn’t meet the margin requirements.
Under the regulation of financing and malicious short selling, the meltdown began. (左怡帆 2016). On the one hand, the meltdown reflects the blindness of market regulation. The blindness is determined by market players.
(高书立 2015) The Chinese stock market is special that individual retail investors are dominant players. Because of lacking of professional knowledge, those investors conducted the blind mass actions of buying and selling.
In this way, investors immediately altogether purchase the stocks when the market performances well, and sell the stocks when the market crashes. On the other hand, since players are not professionals, financial analysis on the media has been the most important way to assess information.
However, people-daily fails to lead people to regain the confidence in stock (新闻研究导刊 2015). Indeed, the government has not stopped the media from inciting investors with the wrong notions. Thus, investors have been nervous, sell outs have been high and alternative source of investment sought.
Finally, Chinese stock market meltdown is alongside with the currency devaluation. Basically, the economy of China is not as good as what the index performances. China transforming from industry intensive economy to capital intensive is still in the process. The booming of stock market indeed is a paradox, which triggers the soaring and slumping prices in A shares. The manufacturing sector had a slip downwards since the beginning of the year. This lowered confidence of the investors.
Section III Regulations The regulations can be categorized into three parts. Firstly, to increase the money flow through diversified policies. The central bank cut interest rates and reserve ratio to a record low, and the government carries out the quantitative easing. Secondly, the CSRC strengthen the management of transition to propose rational trading. They adopted the “Circuit breaker”, limited illegal short selling, relaxed capital access (put pension funds into stocks), and modified related systems. Thirdly, the government raised the funds through top 21 securities brokerages who would invest at least 12 billion in blue chips, required ordered company executives not to sell their shares, suspend IPO (曾薇, & 尹恕好 2016).
Those strategies appeared to adjust the supply and demand in the stock market. Specifically, the government aimed to transfer the excessive supply caused by the falling to the mass demand of stock.
(易宪容 2015). However, the regulations only work for a while, and then the SSI resumed to decline. Indeed, the supply and demand should be adjusted to the market automatically rather than to mandatory regulations.
It is obvious that the government innervations affect people’s ability to analyze the market and estimate the risk, and also individual investors are negatively affected by the regulations, making blind actions.
For example, “Circuit breaker” (When the SSE Composite Index changes reach 5% in both directions, the market will pause transactions for 30 minutes; When the change of index reaches 7% in both directions, the market will close for the day.
scenario) (Finance Sina 2015) is perceived as a sign of selling of. Chinese investors are lack of confidence about China stock market. The introduction of the circuit breaker instead of safeguarding the interest of the investor caused the negative response.
The reaction of the circuit breaker was mass fear by investors of being cut off during the automatic shutdown. In return, $3.2 trillion was lost during the wipe out. To think about Chinese government’s orientation with legal academics, the bailout of the stock market is under risks. China lacks of financial emergency laws to provide legal supports for financial rescue. Since the legal regulatory framework lags behind the bull market, investors cannot figure out the relationship between supply and demand, and conduct risk assessments. Moreover, the regulations fail to clam investors down, resulting in more blind investments and higher volatilities. (熊月圆 2016). Massive money flow caused by expansionary policies will inflate the market because the supply is beyond the demand. The government actions easily stimulate an investment behavior of high risk and this risk will be transferred to individual investors, resulting in a potential threat to the market. (张恺翔2015).
Moreover, Shanghai-Hong Kong express also has a huge impact on A shares. The purpose of opening shanghai-Hong Kong express is to let foreign capital inflow to Chinese capital market, thereby increasing money flow ( 武翰. 2016). However, this behavior did not work well in saving the market. Firstly, the degree of openness is so narrow that the part of the overseas capital is reluctant to enter the market. In addition, the government put too many restrictions on investments and transactions, and as a result, the market loess potential investors. The most important part is that Shanghai-Hong Kong express request more professionals because the system is different than that of the mainland market(王强, & 尚松辉 2015).
The loosening of investment requirements for the Shanghai and Hong Kong markets was meant to attract more foreign investments into the Shanghai market. This would help in taming the falling prices in the Shanghai markets and help in brining stability (Hunter, 2014). However, the move was not openly accepted by the foreign investors most of whom were concerned about increased government intervention in the market particularly with regard to the devaluation of currencies, the freezing of trades, and direct control on the prices of securities in the markets. It is particularly important to note that the authorities still limited foreign investment in Chinese stocks to Rmb13bn. The best indicator of the market reception of the more flexible regulations was the 36% drop in the markets despite the announcement of the more flexible trading requirements.
Section IV appropriateness of regulatory policies Even though a series of market regulations seems to stabilize the market, the real risks have not been eliminated. The government actually transfers the risks from the stock market to other sectors (易宪容 2015). For example, CSRC requests insurance company to postpone debt collections, this action that diverts the risks caused by high margin trading to the bank and insurance companies. In addition, this stock crash also discloses too much government interference (张恺翔2015). Because the regulations were not consistent with the spontaneous adjustments of the market itself, those regulations fail to save the market.
Facing such dilemmas, the government is supposed to be aware of the appropriateness of the regulations. First of all, the government should not intervene the market excessively; Then, the government should follow the “3 T” standards: targeted, timely, and temporary; Lastly, it is better to assist the market to recover its ability to adjust by itself(张恺翔2015). Moreover, in order to change the radical problems, the government also should figure out when is appropriate to leave the market, reform the stock market with a better system, and boost the real economy.
Conclusion Within past few years, China has already taken a place in global economy. It is easily to find out most products are made from China. The Chinese stock market meltdown, for sure, will have a significant impact on world’s economy. Currently, China’s economy is transforming from industry based to consumer driven, closed economy to an open economy. China has a huge potential in the future. While volatility may be of concern to investors, it could essentially signify movement of a new direction for China. The volatility could be as a result of China trying more conventional interventions. If this proactive process continues, we should see a more long-term solution that will positively develop the economy of China and maintain the country’s sustainability.
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