The government stepped in to stem a rout of China’s stock markets in July by banning sales by major shareholders and arming a state agency with $400 billion to support prices, among other measures. It then backed away during another slide in August, sending stock markets around the world tumbling. The benchmark Shanghai stock index had more than doubled in a year as China lowered interest rates, and state-controlled media characterized the surge as an affirmation of President Xi Jinping’s economic policies. The same off-and-on controls are being used in other arenas. China devalued the yuan on Aug. 11 and said it would rely more on supply and demand to determine the currency’s daily government-set fixing to the U.S dollar. It’s facing a key test of its progress toward embracing market forces as the International Monetary Fund will consider whether to include the yuan as a reserve currency for global central banks later this year. China still manages the exchange rate and limits on the amount of yuan that can flow in and out of the country. Most interest rates are now determined by market forces — except for the benchmark deposit rate — though the central bank steps in when the money market is hit by bouts of volatility. There are also efforts to extend a government lifeline to heavily indebted property investors, state-owned companies and local municipalities.
China’s Soviet-style planned economy has been transformed since Mao Zedong derided market-leaning party members as “capitalist roaders” in the 1960s. Today there are more individual stock investors — 90 million — than Communist Party members, and most have less than a high-school education. There’s a shift away from state-directed bank lending and a plan to develop stock and bond markets to fuel growth. At a meeting of party leaders in 2013, policymakers pledged to widen the use of markets, giving them a “decisive” role in allocating resources. They also want to rein in a credit boom and a shadow finance system outside the reach of regulators. The buildup has evoked comparisons with Japan’s debt surge before its real estate and stock market bubble burst in the late 1980s. China isn’t the only country to intervene in times of market meltdown, and central banks around the world have often sought to provide extra funding during times of turbulence. In Europe, some countries temporarily banned short selling during the region’s debt crisis in 2012. Japan tried to stem a stock market slide in 1992 by buying stocks with public funds.
The IMF and China’s trading partners argue that the country needs to loosen the guiding hand of the state and better integrate with the world’s financial system. The U.S., which has scolded China on and off for decades for keeping the yuan weak to boost exports, says it must do more to speed reform. China’s intervention in the stock market hurts the credibility of its efforts so far, and is fueling volatility in global markets by sending confusing signals about its intentions. There’s concern about the moral hazard of a hybrid system where investors assume the government will intervene in times of trouble. The support raises questions about the commitment of its leaders to move to a system where money is priced according to risk and allocated via independent forces, rather than channeled to support asset prices or state-owned enterprises at the government’s bidding. They are well aware that moving too quickly to loosen controls, or mishandling the process, could spur turmoil.
The Reference Shelf
- The Guardian explored the contradictions of a capitalist China in a July 2015 article about the country’s stock markets.
- Bloomberg Brief provided analysis and commentary on China’s stock market tumble in July 2015.
- QuickTakes on China’s debt bomb and currency liberalization.
- The International Monetary Fund addressed the need to allow markets to set China’s deposit and lending rates in its annual report on the country in July 2013.
- IMF paper from 2009 on interest rate liberalization in China and comparisons with Finland, Norway and Sweden.