The 2016 trading year has started off with a major drop in China’s stock market. Trading was interrupted for the second time in just a few days today after share prices dropped by seven percent. The market’s new automatic circuit breakers then kicked in. Shareholders and investors in China have been shaken by these developments, which have obvious global ramifications.

We spoke to Prof Sebastian Heilmann, Director of the Mercator Institute for China Studies (MERICS) in Berlin, about the matter.

What do you make of the current developments?

China’s stock markets are effectively broken. They have always been regarded as something of a casino. But now they have become much too risky, even for speculators. The Chinese government’s competence to manage the economy has taken a hard knock, notably also at home, because of the stock market crashes people have kept on seeing.  Evidently, the efforts Beijing has made since last summer to get the stock market back under control and bolster it with the help of huge cash injections have all come to nothing. Various other economic indicators also show that the government’s measures to stimulate economic growth have not had as much of an effect as it had hoped. 

How important are the new stock-market regulations on suspending trading and the restrictions on selling shares for large shareholders?

The new rules on halting trading in the event of above-average share-price losses have made the pressure to sell quite acute. What triggered the latest crash was the pending reversal of the existing ban on sales of shares by major shareholders. The government’s decision to impose rather arbitrary trading restrictions of this kind that run counter to stock market dynamics has had a highly negative effect.  Big and small shareholders alike were determined to take profits after the upward move they had seen in the final months of 2015. They sold their shares at the earliest opportunity in the New year, just before the presumed expiration of the sales ban imposed on major shareholders, which has the potential to bring about another round of drastic market correction. 

What does the stock-market crash mean for China’s real economy, which appears to be slowing progressively?

China’s stock markets have never been a direct reflection of how its real economy is performing. The Chinese government has rather chosen to use them as a means of raising capital for often debt-ridden state-owned enterprises. However, if neither the stock markets nor banks can serve as a reliable source of capital for major enterprises any longer, then this will have a decidedly negative impact on the growth of the Chinese economy.

So what needs to happen to revive the stock market, then?

Shareholder confidence will only be won back again if every listed company is obliged to make comprehensive reports on its business operations that are independently evaluated and reviewed by trustworthy regulators, auditors and market participants. Only on that basis is it possible to gauge a firm’s share price properly, an assessment that may also lead to a determination that a given company may have to withdraw from the stock market altogether. The current approach -- piecemeal intervention by regulators -- won’t make up for what trust has already been lost. If it wants to resurrect the stock market and listed businesses, the Chinese government ultimately has little choice but to make companies and markets subject to a completely new set of rules and regulations. However, since the government wishes to retain political control over the stock market, it’s unlikely that any far-reaching steps of this kind will be taken. 

What kind of political effect will this dramatic situation have, do you think?

It’s likely that some political pawns will be sacrificed. I expect reshuffles in the China Securities Regulatory Commission or even among top-ranked economic policymakers. It’s quite likely that a close associate of Premier Xi Jinping’s will take over as director of the Regulatory Commission. This step won’t make the market calm down for long, though – and it actually exposes Xi himself to more risk since it will clearly be “his” team that’s running things Personnel moves aside, the obvious failure of market regulation may also destabilise the political situation domestically. The loss of control apparent in economic policy, alongside the much greater risks that now exist for the ruling elites, which have a lot to lose as a result of the economic slowdown and growing uncertainty, all add up to a dangerous mix. The Chinese leadership made a dangerous bet when it chose to make a sizable part of the Chinese people rich by investing in stock markets.  While this move may have bought them loyalty when the market moved up, this “loyalty” – based on stock market increases – may now backfire in dangerous ways as the household finances of relevant segments of the Chinese public are taking direct hits.

What should European investors and entrepreneurs be prepared for?

I reckon investment activity in China itself will drop quite significantly due to growing uncertainty in many Chinese businesses. Germany’s car-manufacturing industry, mechanical-engineering sector and chemical industry are particularly vulnerable to negative developments in the PRC.

China’s economy is currently in the middle of a major upheaval. Many industrial and financial indicators suggest that the country will have to reckon with a significant slump in economic growth over the next few years. Since China has served as a growth engine for the world economy over the last ten years, any such slump it suffers will affect its trading partners and investors, too – firms that have all profited from the recent boom in China up to now.

Conversely, the difficulties now encountered in the Chinese market harbour a number of opportunities for European economies with regard to attracting Chinese outbound investment. European companies, property markets and start-up hubs have the potential to become an ever more important destination for Chinese investors. Overall, I expect more capital to flow out of China. Chinese stock markets may remain in a mess for the foreseeable future. But the age of global Chinese capital investment has only begun. 

 

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