Market Views: Counting the cost of China’s A-share intervention
As the coronavirus has revealed, diseases can spread quickly. But not as fast as information.
The outbreak of the flu-like virus led to a broad expectation that the A-share market would see a panic selloff after mainland Chinese stock exchanges reopened last week.
They didn't disappoint – yet they also recovered quickly. After losing close to 8% in the first day of trading on February 3, the Shanghai Composite Index quickly rebounded and had regained around 4.7% as of February 10, just a week after the selloff.
Several measures the Chinese government rolled out to cushion the blow could contribute to the unusual rally. In addition to extending the Chinese New Year break and a Rmb1.2 trillion ($174 billion) liquidity injection by the People’s Bank of China, there were signs that the “national team” of Chinese institutional investors had bought stocks to prop up the market.
China has historically been sensitive about volatility in the capital market, and it has often sought interentionist means to stablise it if needed. But now that A-shares are gradually becoming available to foreign institutional investors – through regulatory relaxation and index inclusion – a controlled market may not be as efficient as a free one in accurately reflecting risks.
We asked four market experts about the pros and cons for foreign investors of Beijing interfering in its domestic equity market once again.
The following extracts have been edited for clarity and brevity.
Chen Zhiwu, director, Asia Global Institute
The University of Hong Kong
It is understandable that, given the extreme concerns and uncertainty about the coronavirus, the Chinese regulators want to manage the A-share market volatility. It is also no surprise as they have almost always intervened since the very beginning of the A-share market.
But they must understand the implications of their actions. There is just no free lunch.
Market interventions create distortions, making the pricing and resulting allocation of capital more inefficient, destroying the very purpose of having a stock market.
It has also been popular among regulators and others to complain that the A-share market has gone in different ways than China’s economic growth performance and that investors have not made money from investing in A-shares. But their constant interventions have often pushed up blue-chip shares and made investors pay much more than justified on valuation grounds, so it's not surprising they end up losing money.
All interventions distort prices and cause misallocation. This is why the A-share market has been largely a sideshow to the Chinese economy and cannot be counted on to play a major role. More interventions will simply make the A-share market even more irrelevant.
Such interventions amount to wealth transfer from small investors to institutional investors, especially foreign investors. Foreign institutional investors tend to congregate around a few big-name companies that are components of key stock indices.
Mark Tinker, founder
When considering the Chinese authorities' moves to stabilise their markets this week we should bear in mind that this came after the Chinese markets had been closed for several days due to the lunar new year holidays during which other markets had fallen sharply, especially elsewhere in Asia. As such it is perhaps best considered as stabilisation rather than interference or manipulation.
It is worth remembering that the Chinese markets are still dominated by small retail and more generally the authorities tend to move to manage leverage and excess margin trading in markets to try and maintain stability.
Law Ka-Chung, adjunct professor, College of Business
City University of Hong Kong
Former chief economist and strategist
Bank of Communications
The true meaning of “market” is by definition free trade. If the behaviour of buyers and/or sellers are forced to any extent then there doesn’t need to be a market. It's worth remembering that a market crash is not necessarily due to market failure. Indeed most of the time it isn’t. But most rescues are due to political reasons.
The cons of doing so are obvious. Market trade relies heavily on agreement of a set of game rules. Any interference is bound to violate the rules and should only be conducted when someone is trying to break such rules (especially illegal trades). Natural crises should certainly be beyond this.
However, the Chinese Communist Party has no political will to follow the market rules established by Western world. Nor are they ready to open up and let the market survive under shocks. The mindset of a dictatorship will never be consistent with free market but strict interventions.
Both returns and risks are defined with respect to time. Of course in retrospect when intervention was conducted over the past week the return was high and risk was not. Yet things are not that simple, and when interventions are frequent the market won't behave normally.
These interventions introduce political or policy risks to the market which are difficult to quantify, and the market simply places a risk premium on top. If the China market offers the same expected return as the others, market participants might prefer the others because it is more risky due to the policy risk premium.
Alicia Garcia, chief economist for Asia Pacific
Beijing has a history of market intervention, sometimes successful and sometimes unsuccessful. Last Monday (February 3), even if mainland China stock markets went down more than 8%, there was still substantial intervention via China Connect (i.e. money coming in from outside of the country).
Investors saw the government-driven intervention and stepped into the market on Tuesday morning to make gains. This is basically moral hazard created by the government which allows those better informed to make a gain.
This, unfortunately, also means that the Chinese stock market is unrelated to fundamentals and does not really offer maket signals but rather government-related ones.
Foreign investors could benefit if they follow the crowd but they tend to come always last so they cannot really compete with those appointed by the government, directly or indirectly. In other words, foreign investors can make some profit from the intervention but they may also be the last to leave when the direction changes.
Philip York, chief executive
Alt 224 (a trading firm based in Hong Kong)
Throughout history we can trace government overspending and interference as one of the greatest causes of misery and hardship in society.
In 1989 the Japanese government swore to defend their stock market from collapse and thereby bankrupted the largest fund in the world. More recently the Japanese (and the Europeans) have taught us that artificially low interest rates don’t stimulate growth.
In the 1990s [US president] Bill Clinton, seeking to make mortgages on homes more affordable, warped the mortgage market through a series of changes that were instrumental to the 2008 global financial crisis.
In 1998 the Russian government continued to spend foreign reserves to support its overvalued currency. By August it had run out of money, the currency collapsed and the country defaulted on its bonds.
China also has a long history of failed interventions, from wasting countless millions supporting the yuan to supporting equities in a bear market.
Thanks to the industrious nature of the Chinese people, the country’s economic growth has only been hindered by these interventions. Time will tell whether Beijing chooses to continue to squander its wealth with intervention and eventually destroy the economy, as the Europeans and Japanese have destroyed their currencies and debt markets.