China's stock market rebounds, but excessive borrowing may be the real issue

While the bold measures implemented by Beijing are failing to keep the market afloat, the real problem may lie in the fact that the funds originally used to buy stocks were borrowed.

A worker repairs the display board at a brokerage house in Fuyang in central China's Anhui province Wednesday July 8, 2015. China announced a flurry of new moves Wednesday to halt a stock market slide. The government told state companies and executives to buy shares, raised the amount of equities insurance companies can hold, and promised more credit to finance trading.

Chinese investors, who watched their stocks drop dramatically over the past few weeks, breathed a sigh of relief on Thursday as Beijing’s audacious attempts to keep the market afloat seemed to finally pay off. 

Despite numerous new measures to prop up the country’s floundering stock market, stock sell-off in China had continued unremittingly over the past few days. But the Shanghai composite suddenly bounced back on Thursday, finishing 5.8 percent higher, the largest one-day percent increase since 2009. Shares in the Shenzhen index, likewise, jumped up 3.8 percent.

But before feelings of jubilation could fully sink in, analysts began warning that China’s market may continue to fall in the coming weeks. The recent plunge represents the end of a bull run that began in the summer of 2014 and reached its peak mid-June. Now, while the bold measures implemented by Beijing may be circumventing a sudden and devastating plunge, the real problem may lie in the fact that the funds used to prop up the market in the first place were borrowed.

“One clear lesson of the past 15 years in the US is that a big asset price decline only has to be economic disaster if those assets were bought mostly with borrowed money,” wrote Justin Fox for Bloomberg.

“So, sure, the stock market collapse of 2000-2002 was painful, but nothing like the housing-price collapse of 2007-2009,” he continued.

“Yet Chinese officials have been encouraging people for months to buy stocks with borrowed money, and Chinese speculators have responded by borrowing an estimated 3.8 trillion yuan ($610 billion) for stock purchases.”

While the exact amount of borrowing is unknown, some estimates have put the total amount at around $550 billion. That could put both brokerage firms and banks in jeopardy, analysts say.

Moreover, because so much of the money supporting the stock market is leveraged, there has been increased pressure to sell following the downward dip. This may be part of the reason the government failed to inspire sufficient confidence to keep many investors in the market. Much of the borrowing was done by ordinary, middle-class Chinese investors, some of whom mortgaged their homes to invest in stock. Relying on the government’s ability to keep the market afloat may be too chancy for some of these investors, who risk having their savings completely wiped out.

Certain relief efforts are still underway. As the stock market dipped over the past several weeks, the Chinese government eased borrowing measures and began encouraging investors to put more money in stocks. On Sunday, China's central bank announced it would inject cash into the China Securities Finance Corp, a state-owned company that finances margin trading, or trading with borrowed funds. Chinese speculators are now even permitted to use their houses as collateral for borrowing to buy more stocks, a move Bloomberg reporter William Pesek characterized as  “sowing the seeds of a third financial time bomb to match its [China’s] debt and stock bubbles.”

Furthermore, the country’s largest brokerage firms have banded together to create a $19.4 billion stabilization fund to alleviate the market and even buy stock funds themselves. China’s brokerages have promised to continue purchasing shares in their proprietary accounts as long as the Shanghai Composite is under 4500. It is currently at 3506. The idea was to demonstrate to smaller investors in need of reassurance that the big fish are still willing to swim in the pond.

The creation of an additional fund to purchase shares in smaller and midsize companies was also announced on Wednesday as the stock market continued to plummet, the New York Times reported. And the government even ordered state-owned companies not to sell shares. Still, none of these measures seemed to be staving off panic selling, until Thursday.

Meanwhile, due to an exchange rule that imposes a daily up and down limit of 10 percent for stocks and mutual funds, trading has been suspended for around 900 stocks each day after they dipped below the stipulated threshold. Some companies have also requested that their stocks be suspended while they wait for the downturn to pass. So far, over 1,400 Shanghai and Shenzhen-listed companies suspended trading in their shares. As a result, investors intent on selling Chinese shares found themselves locked out of over 70 percent of the market. This situation continued unabated Thursday.

“Trading halts will affect investor confidence,” Bernard Aw, a strategist at IG Asia Pte Ltd. in Singapore, told Bloomberg.

“Individual traders will still offload the counters when trading resumes, unless there is a considerable change.”

Now, some experts are wondering whether the plunge is just a normal correction after several years of hasty growth, during which the Chinese market doubled, tripled, and even quintupled, or whether it’s a harbinger of a more sustained economic downturn in China.  

Some analysts have speculated that China’s financial problems may not be as bad they seem. Despite the drop, even Wednesday the stock market was still up around 70 percent compared to when the boom began a year ago, and the Chinese stock market isn’t as big relative to the rest of the economy as it is in other developed countries, such as the United States.

“The property market is already down, people still have jobs -- in fact the labor force is shrinking -- and exports are still stable in my view, and big infrastructure projects are still stable,” Andy Xi, an independent Shanghai-based economist, told the International Business Times.

 “So the real economy is not going to crash.”

Meanwhile, the stock market crash didn’t hampered the investing prowess of some major firms. On Wednesday the e-commerce giant Alibaba announced it has invested in, a Chinese platform for luxury and fashion goods. While the exact figure has yet to be confirmed, a source close to the deal told Tech Crunch that the amount is close to $100 million. Meanwhile, the company has also reportedly upped its stakes in the telecommunications company the Singapore Post.

Still, if tens of millions of Chinese citizens face losses, it could impact consumption, and consequently, the rest of the economy.

 “Individual Chinese make up more than 99 percent of China's stock investors and account for roughly 10 percent of daily trading volume,” the Monitor reported Wednesday.

Now, experts are warning that the period of reprieve purchased by government intervention may have longstanding repercussions.

"The authorities are capable of slowing the selling and extending market support," Mark Konyn, chief executive officer at Cathay Conning Asset Management Ltd in Hong Kong, told Reuters.

"However, this high level of intervention comes at a significant cost. Such intervention locks up ownership of shares, reduces liquidity and creates an overhang that could plague the market for years."

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