China’s stockmarket

Crash course

China's stockmarkets have been sliding for months

CHINESE investors had a rare opportunity for good cheer on Wednesday February 27th. The country’s two stock exchanges shrugged off Monday’s blues, when both indices dropped by about 4%, and gained a bit instead. Unfortunately Monday is far more typical of trading conditions in recent months in the country’s two markets, in Shanghai and Shenzhen. Despite the power of China’s interventionist government, the importance of maintaining appearances for the Olympics and the country’s relatively strong economic growth, China’s stockmarkets have been suffering from a protracted slide.

Shanghai is already down by more than a third since October last year. A fall of this severity, had it happened elsewhere, would have already prompted the word “crash” to circulate. But the collapse has sent out few tremors and little nervous talk. There are several reasons why this is so. Foremost, foreign participation in the Chinese market has been strictly curtailed. As a result global losses are limited and so news of the financial destruction that has accompanied the massive share-price losses has failed to stir interest beyond the country’s borders.

Exactly a year ago a 9% tumble of Shanghai’s stockmarket sent a shockwave around the world that knocked a couple of percentage points off the Dow Jones Industrial Average in a matter of seconds. Now, perhaps, with damage spreading through the global credit markets, there is a sense that there are bigger things to worry about.

There are also reasons to believe that the losses—in excess of $1 trillion—are not as devastating as they first appear. Much of the capitalisation of the Chinese markets is tied up in shares held by the government, so whatever the extent of the losses, less than half has been borne by private investors. China has a huge number of brokerage accounts—upwards of 115m and 70,000 new ones are established every day—but many are inactive. And unlike in many Western countries, the stockmarket appears to play a relatively small role in providing capital for companies, with bank loans and retained earnings statistically far more important.

But even with these caveats the losses are still wrenching. Estimates of active brokerage accounts range from 10m-15m and an equal number of people have invested in mutual funds. Bank financing and the reinvestment of profits do play a huge role in Chinese corporate finance, but equity markets became extraordinarily important last year.

Through initial and secondary offerings, Chinese companies raised in excess of $78 billion domestically and more money came in through linked overseas placements. The inflow of new equity allowed companies to increase their capacity to borrow and raised the capability of banks to lend. A receptive public market led to the creation of a vibrant “pre-flotation” private market and improved the ability of private equity to raise funds, each of which supplied billions of dollars of additional capital. All of this is now at risk.

The change in circumstances has not escaped the notice of China’s interventionist government. Two big companies recently announced large secondary offerings: Ping An Insurance and Pudong Development Bank. The share prices of both have been slammed, possibly because of the expectation of dilution, but possibly because there is no appetite for new shares. In response to the falling market, the China Securities Regulatory Commission warned companies against secondary offerings. Ping An is widely expected to reconsider its huge offering. In a further move to bolster prices, the government is rumoured to be on the verge of reducing a stamp tax on transactions.

There is, however, only so much that government intervention can achieve. Current valuations, even after the recent sell-off, are still sky high. In the past year, many companies earned substantial profits from gains on stockmarket investments. A repetition is unlikely. More realistically, given the market’s decline, profits will suffer, depressing results and pulling share prices further down in a vicious circle. If that process truly kicks off, no one will argue about whether China’s stockmarkets are crashing or not.