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29 January 2016, Gateway House

Why falling stock prices make China nervous?

China’s stock market has tanked over 20% in January 2015. More than the fall in the stock market, it is the reaction of the Chinese authorities that suggests bigger problems.

Senior Fellow, Energy, Investment and Connectivity

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An important milestone in any financial crisis is to literally, blame the ‘Jews’ – which in our politically correct times has become ‘blame the short-sellers’. It is ludicrous to believe that financial crisis is caused by conspiracies of short-sellers or religious minorities than an economy’s own weaknesses. Luckily for bigots, hedge fund manager George Soros personifies both. Many may recall Malaysia’s Prime Minister blaming Soros for causing the 1997 East Asian currency crisis. The more conspiratorially inclined had also drawn a link between Soros’s Jewish heritage and hence his alleged desire to undermine a promising ‘Islamic’ economy.

Now it is China’s turn. A front page opinion piece titled ‘Declaring war on China’s currency? Ha ha’ in People’s Daily, the newspaper of the Chinese Communist party, warns Soros not to bet against the Yuan. Also, a commentary in Xinhua, the state owned news agency, warns ‘reckless speculations and vicious shorting will face higher trading costs and possibly severe legal consequences.’ It is remarkable that a government with over $3 trillion in reserves feels the need to ‘warn’ off a speculator whose war chest is less than 1% of the Chinese government’s kitty.

Meanwhile, on 26 January, China’s top statistician was arrested as a part of graft investigation. China’s official statistics have always been considered of doubtful veracity – this move is unlikely to improve trust. In mid-2015, China had arrested a large number of short sellers, blaming them for the falling stock market. A business journalist was also picked up – who later confessed on television his guilt in manipulating the stock market.

These arrests were only a part of the efforts to stop the rout in the Chinese stock markets. Hundreds of companies ‘voluntarily’ wrote to authorities asking for their shares to be suspended from trading – there was a point in July 2015 where just 3.2% of the listed companies in China could be traded normally. State backed funds also started to buy shares in a big way.

What is the problem?

China’s stock market is down 40% from its peak and has tanked over 23% so far in January 2016 – that’s an over 1% drop for every trading day so far. This has led to a number of tragedies – people have committed suicide after losses in the stock market. China’s foreign exchange reserves have fallen by over $500 billion in the past year as investors have rushed to the exit. It has been pointed out repeatedly and correctly that China’s economy is not connected to the stock market. If that is the case, why is the Government in such a panic to stop the slide?

More than the Chinese economy, it is the Chinese government which needs to worry.

China’s people have an extremely high rate of savings – at about 30% of disposable household income, while the richest 5% of the households are estimated to save 70% of their incomes – accounting for half of the total savings. China’s banking system for the most part has offered either negative or very low real interest to savers. Meanwhile, some Chinese people have a love of gambling – evident from the mega-casinos of Macau. The stock market offered an alternative to park money and gamble – evident from the 100 million retail trading accounts and the fact that retail traders accounted for up to 80% of the market volume in China.

Therefore, the 40% plus fall in the stock market means a significant financial hit for the middle and upper middle classes. China’s bull market of 2014-15 has been referred to as the ‘State Bull Market’ and ‘Uncle Xi’s Bull Market’. If that’s the case, then can a fall also be blamed on the government? The fall in the stock market means that millions of middle class investors have lost money on what they thought was a sure bet, backed by the government. An angry middle class isn’t good for any ruling class – least of all a ruling class that suppresses dissent in all forms.

Economic problems brought about by the East Asian crisis led to the departure of Indonesia’s Suharto. The beginnings of Arab upheaval were partly due to economic issues as well. The Bolivarian revolution in Venezuela has lost steam as well as elections, also because of public dissatisfaction with a poor economy. China’s government, same as many other authoritarian regimes, has an unsaid covenant with its people – we’ll give you growth and a good living standard, and you don’t question our right to rule. Flagging growth and lost middle class savings can weaken this covenant.

India has a mechanism to boot out an unpopular/non-performing government – giving vent to the popular sentiment. China doesn’t. Therein lies the problem.

Amit Bhandari is Fellow, Energy & Environment Studies, Gateway House.

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