Big bubble in brittle China
The new year has brought fresh problems for officials in the higher echelons of the Chinese Communist Party (CCP), and considerable uncertainty for investors rocked by another spate of financial market instability.
The sudden fall in the value of Chinese assets, and the accompanying currency depreciation and widening of spreads between onshore and offshore renminbi, stems from a confluence of factors raising clear questions about China’s financial sector liberalization path, and ability to manage a soft landing for the economy as it transforms from a predominantly industrial-led powerhouse to a consumer-driven one.
This, the second major episode of financial distress in approximately six months, was largely triggered by a Jan. 8 deadline, ending a ban on stock sales by major shareholders, which naturally encouraged smaller shareholders to dump their holdings. Stocks fell too in response to depreciation of the renminbi after the People’s Bank of China (PBoC) set a higher fixing rate, a move that would naturally encourage the sale of local currency-denominated assets. Support for the exchange rate in December had, it turns out, wiped $108 billion off China’s still-enormous foreign exchange stockpile, devalued to $3.33 trillion.
However, it was also the authorities’ ill-judged move to impose “circuit breakers” in a belated response to the stock market collapse last June/July that contributed to the panic, putting a halt on trading for 15 minutes when the Shanghai Shenzhen CSI 300 index of A-listed stocks fell 5%, ultimately closing the market for two days in succession following falls of 7% (see “Trouble is brewing,” below).
The circuit breakers did the job of limiting the losses, but what is not clear is why they were introduced at all given that a pre-existing regulation enabled the market to be suspended following a 10% drop in value. That highlights the inconsistent approach to policymaking and poor communication in the one-party state, which is deeply alarming considering the global impact China has and the necessity for it to embark on reforms to deal with the mounting debts accruing to state-owned enterprises.
In the end, the authorities admitted their mistakes by removing the circuit breakers and extending the deadline on large shareholder sales to restore stability. Yet by delaying the more difficult decisions required to deal with these problems, there is no guarantee against avoiding future instability, especially since the PBoC must balance systemic risk and currency depreciation objectives. Added to that, the initial response to calm market jitters gives the sense China is moving away from the path of gradual financial liberalization.
In addition to restricting state bank dollar sales to households and corporations in Shanghai and Shenzhen, and imposing new documentation requirements, the PBoC intervened in the Hong Kong market to sell dollars/purchase renminbi while temporarily restricting, it is believed, onshore/offshore renminbi currency trading by foreign-owned banks.