Chinese volatility raises spectre of hard landing

To misquote Oscar Wilde, ordering a stock market shutdown once might be regarded as a misfortune but to do so twice in less than a week looks like carelessness.

However, after an early shutdown three days ago China’s stock markets again closed prematurely on Thursday – this time less than 15 minutes after opening, to mark the shortest-ever trading day since their launch 25 years ago. The closure was triggered by an automatic circuit breaker after the indices on both the Shanghai and Shenzhen markets fell by more than 7%.

The further bout of stock market jitters, which have spread to other major global exchanges, represent a replay of last August’s volatility when a sudden and unexpected devaluation of the renminbi (RMB) upset investors and renewed concerns on the state of China’s economy, the world’s second-largest.

In recent years, the health of the global economy has increasingly been seen as depending on China’s successful adjustment to an era of more sedate growth after a prolonged period in which it regularly exceeded 10% year-to-year. Hopes that a so-called “soft landing” could be achieved for the Chinese economy are increasingly looking likely to be disappointed, not least because of the uncertain response of the country’s policymakers.

At the start of 2016 Beijing introduced a circuit breaker on both exchanges in a bid to prevent a repetition of last summer’s stock market volatility. This promptly went into effect on Monday after the Shanghai index fell nearly 7% following the release of weak Chinese manufacturing data. Trade was initially halted for 15 minutes, but as stocks showed no sign of reviving the rest of the trading session was cancelled.

An unintended effect

The even swifter shutdown on Thursday, following two days of efforts by the Chinese authorities to stabilise the markets, suggests that the introduction of the circuit breaker may have backfired. Rather than reassure investors on the stability of the markets, it has instead triggered fears that they will be unable to promptly offload unwanted shares.

Indeed, Phillip Securities analyst Chen Xingyu told Agence France Presse (AFP): “The use of the circuit breaker is the main reason for the falls as investors panicked after seeing it being triggered on Monday.

“The circuit breaker has cut off the market liquidity and investors are afraid they won’t be able to sell. The market-selling pressure was originally not this heavy. China shouldn’t have used a tool of a mature market when most of its investors are individual investors who panic easily.”

The two main questions now are firstly whether the entities that have attempted to stem the markets’ decline in recent months by buying up shares on behalf of the government will continue their work. Analysts regard their efforts as no more than a temporary sticking plaster, but the China Securities Regulatory Commission (CSRC) remains adamant that its national team “will not quit” and continue with its mandate to stabilise the market.

The Financial Times cites an estimate from last September by Goldman Sachs, which calculated the cost of Chinese government efforts last summer to prop up the stock market at RMB1.5 trillion (US$234bn). At that time the main index had fallen by around 45% from its peak in late-June 2015.

The “national team” owned at least 6% of tradeable market capitalisation in the Shanghai and Shenzhen exchanges at the end of Q3 2015, said Goldman Sachs.

The CSRC is also prolonging a restriction that was due to expire later this week on share sales by large shareholders. It prevents shareholders who own more than 5% of a quoted company to sell more than 1% of the holding in any three-month period.

Secondly is the question of whether Beijing will make any efforts to control the accelerating rate at which the RMB is depreciating. The currency’s reference rate is set by the People’s Bank of China (PBoC), which has lowered it in each of the last eight trading sessions, although earlier this week forex traders reported that China’s central bank was drawing on its foreign exchange reserves to support the currency.

The World Bank is predicting that China will experience only a modest slowdown in economic growth during 2016 – to 6.7% from an estimated 6.9% last year. Given than many of its other forecasts for the global economy are bleak, the hope must be that this is a realistic assessment.

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