Commentary on Political Economy

Tuesday, 7 July 2020


Why Beijing is stoking China's share market frenzy

Karen MaleyColumnist
The rally in Chinese shares shows little sign of running out of steam, with the Shanghai stock exchange recording a 1.5 per cent gain at 4pm on Tuesday afternoon, following its staggering 5.7 per cent surge the previous day.
It's little wonder that the share market rally is so vigorous. Investors are clearly emboldened by the blessing that China's official media is giving to the blistering rally.
On Monday, the state-run China Securities Journal ran a front page editorial which argued that the foundations for a "healthy bull market" had strengthened over the last three decades, and pointed out that the "wealth effect" from rising share prices would stimulate consumer spending
The previous Friday, the state-owned Shanghai Securities News ran a story with the headline "Hahahahaha! The signs of a bull market are more and more clear."
But this rally - which has lifted the Chinese market to a five-year high - isn't driven solely by rhetoric. Beijing's national team of state-backed buyers, which in the past have stepped in and supported markets during periods of weakness, are again reported to be actively intervening in markets.
Most analysts agree that there are two main reasons for this determined effort to lift Chinese share prices.
The first is economic. As the China Securities Journal editorial suggested, Beijing is trying to engineer a situation where the "wealth effect" kicks in.
Policy makers are hoping that as their share portfolios increase in value, Chinese consumers will feel increasingly confident enough when it comes to spending.
Although economic activity has bounced back strongly in China - a private gauge of activity in China's services sector in June surged to its highest level in more than a decade, while a similar measure of China's manufacturing activity hit a six-month high last month - it still remains far below pre-pandemic levels.
What's more, the recovery in activity in the manufacturing sector is heavily dependent on stronger domestic demand, given that new export orders continue to weaken, and employment remains on a downward trajectory.
The risks is that this worrying weakness in employment - at a time when China faces the challenge of finding jobs for record numbers of university graduates as well as tens of millions of unemployed migrant workers - could undermine the country's economic recovery and fuel social instability.
What's more, the fact that the United States - which is China's largest export market - is still struggling to contain the coronavirus pandemic, suggests there's little hope for an export-led recovery, at least in the short-term.
But analysts believe that Chinese policy-makers have another motive for fuelling the share market rally: and that's the exchange rate.
Beijing has loosened credit and liquidity in an effort bolster the Chinese economic recovery, but is simultaneously trying to keep its exchange rate stable, in order to avoid inflaming tensions with Washington even further.
A strong rise in the local share market is likely to encourage wealthy Chinese to invest in local equities, rather than trying to find a way around the country's strict capital controls. And that reduces the risk that China will see a rise in capital outflows, which would put downward pressure on the Chinese yuan.
For seasoned investors, the latest frenzy in Chinese stocks recalls the heady days of 2015, when the Shanghai composite soared by a staggering 150 per cent from the beginning of year to its peak in June.
Chinese investors - many of whom had borrowed to buy shares - suffered bruising losses when the market then plunged by 40 per cent.
Like 2015, the Chinese share market rally is again highly dependent on leverage, with margin loans - where brokers lend clients money to buy stocks - climbing to 1.16 trillion yuan, the highest level since January 2016.
Still, this is well below the 2.3 trillion yuan peak in margin loans back in 2015, which suggests that the present frenzy in the Chinese share market frenzy could persist for while yet.
However, prudent Chinese traders will be keeping a close watch on state-run media for signs that Beijing is becoming nervous about creating a fresh share market bubble.

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