China's 'Black Monday': Did Officials Do Enough To Stop It?

With China’s economy slowing, and the country’s stock market falling rapidly this week, debate over Chinese policymakers' decisions, and whether they are getting the approach right, has become increasingly heated.

The controversy is not completely new: In early July, with China’s markets starting to plunge after a massive boom compared to the preceding year, authorities announced a massive program of intervention to stem the fall: Major brokerages were effectively ordered to buy tens of billions of dollars worth of shares and had to pledge not to resell them until the market rebounded to a relatively high level; repayment terms for money borrowed to buy shares were also eased.

It helped the market recover by more than 20 percent -- at least temporarily. Yet some analysts criticized this approach as undermining China’s stated aim of moving to a more market-based financial system. Others warned that the market boom had little connection to China’s real economy, and that a major correction was therefore inevitable. Prolonging the process, they said, would only lead to more ordinary investors getting their fingers burned.

Earlier this week, however, as investors ditched shares in a hurry, and panic spread to markets worldwide, it was the absence of Chinese government intervention to boost the market that initially prompted criticism. Some blamed Monday’s stock market fall of almost 8.5 percent on the authorities’ failure to announce a cut in interest rates and the bank reserve requirement ratio (RRR). Investors had been hoping for such a move over the weekend, following the previous week’s 12 percent fall in share prices. They believed this would send a reassuring signal that the government was committed to taking proactive steps to support the economy.

When this announcement didn’t come, however, many investors became fearful, suspicious that the authorities were no longer prepared to invest heavily to “save the market.” As a result, shares fell by a total of more than 16 percent on Monday and Tuesday, at which point the government finally stepped in, with the central bank, the People’s Bank of China (PBoC) announcing (relatively small) cuts in interest rates (0.5 percentage points) and in the RRR (0.25 percentage points), which would, in theory, make it easier for banks to lend to businesses.

The British media seemed unimpressed by the government’s approach: The Times of London spoke of “clumsy Chinese government interventions” and said the roots of the crisis lay partly in “the obscurity of Beijing’s intentions,” while the Telegraph criticized the government’s “seemingly incompetent response, ... desperate attempts,” and “deluded … belief that China’s own peculiar form of authoritarian, state-sponsored capitalism could somehow defy the usual laws of economics.”

The Guardian went further, saying that the world was “losing its blind faith in the assumption that China’s often-secretive political processes can in the end be relied on to steer the nation to ever-greater prosperity.”

Yet other analysts suggested China’s central bank was taking a wise approach: The Guardian’s own economics editor Larry Elliott described Tuesday evening’s rate cuts as “modest but significant,” and said that though the government could have done more, it had now chosen a “more measured approach.” He argued that “slashing interest rates” more dramatically “would have been seen as evidence that the economy was, indeed, suffering a hard landing and might have further damaged confidence.” And he said that the central bank had “timed its move well,” announcing its cuts just as markets in Asia and Europe were beginning to move back up, thereby achieving maximum effect.

Yet with Chinese stocks continuing to fall on Wednesday, despite rallying earlier in the day, some analysts continue to ask whether the government did enough and, indeed, whether it has a clear plan.

Certainly some Chinese investors are voting with their feet. One experienced investor in Shanghai told International Business Times on Tuesday that he was not planning to invest in the market in the near future, as he no longer thought the government was making propping up the market a priority.

Yet if the authorities are now intervening less, this would also appear to contradict what seemed to be a clear strategy of talking up the markets over the past year: Officials repeatedly said the markets were now an important channel for raising the funds needed to restructure China’s economy. Meanwhile, in April, when the market hit 4000 points, a commentator for the official People’s Daily said this was “merely the start of a bull market,” later arousing some public anger from investors who had lost money when the market began to fall. (Though the market later did briefly reach 5,200 points, it wa trading below 3,000 at Wednesday's close.)

Li-gang Liu, chief economist for Greater China at ANZ Bank in Hong Kong, told IBTimes that it was understandable, on one level at least, that the PBOC delayed announcing the cuts earlier this week because it didn’t “want to cut the rate during such a big market rout,” fearing that this “would be seen as an action of weakness.” However, he said such cuts were much needed to help Chinese firms, which faced real borrowing costs of up to 10 percent. And he predicted that a further, and probably bigger, RRR cut, would be needed again in the coming months, if China were to meet its growth target of 7 percent for the year.

Liu also called for further financial market liberalization to create an efficient capital market and make it easier for Chinese firms to raise money by issuing corporate bonds, which currently have lower interest rates than bank loans. “They need to instill some kind of confidence [in] the market,” Liu said. “If the market thinks the PBoC is helping businesses, that will make firms more confident in the second half of the year.”

In practice, however, Liu said it was sometimes “difficult to understand the PBoC’s policy objectives.” In particular, the delay in cutting the RRR led to speculation that authorities were focusing on structural issues, and were, in part, focused on the idea that “lower-capacity firms should be driven out of the market, rather than using a low-interest rate to help them out.” (However, he said, this was “a very risky way of conducting monetary policy; the role of monetary policy is not to engage in structural change.”)

Liu said he had revised down his own forecasts of China’s overall economic performance for the second half of the year, partly as a result of a perceived slow response from the government. “We thought monetary policy could be eased further, fiscal policy could be implemented decisively,” he explained. “But so far, we have been very much disappointed. We haven’t seen a concerted effective policy to combat the very sluggish real sector growth at this moment. The economy will remain quite sluggish in the third quarter for sure.”

He added that China’s leaders had room for further policy moves, “but they don’t want to use it. We don’t see an effective policy coming out of it,” Liu said. Like many economists, Liu is reduced to speculating on the motives of China’s leadership: “Maybe at this moment the top leadership is still looking at employment as this bottom line, and that’s not so bad. So they [think they] don’t have to react so aggressively,” he suggested.

And some analysts are even more critical. Andy Xie, the famously bearish former chief Morgan Stanley economist for Asia, believes that the government’s policy of backing the stock market since last year -- after it had been in a protracted slump from 2008, even as China’s real economy experienced double-digit growth -- was “a mistake” from the start.

“The Chinese stock market is fantasy economics, a show. It’s separate from the real economy. So what we’ve seen is a gambling frenzy -- it started going up in the middle of last year and went up 150% before falling back, while all the time the fundamentals of the economy were sliding.”

Xie, who told IBTimes back in April that the authorities risked creating a dangerous bubble in the markets by making it too easy for investors to borrow funds to buy stocks, says that encouraging ordinary citizens to keep investing in recent months amounted to “taking advantage of the weak people, robbing the people who are most inexperienced.”

And he says the government’s attempts to stem the fall in the market were doomed to fail, noting that similar attempts were made in 2008, before the authorities “finally gave up. … And now they’ve tried but failed again. They can’t stop it. That is the lesson -- that the market is more powerful than the government. So all these theories, especially popular among foreigners, that the Chinese government has some secret plan, has everything under control, that’s totally wrong,“ he added.

Chinese official media remain bullish, saying the economy has strong fundamentals, and infrastructure spending will help boost growth in the second half of the year. Xie, however, sees overcapacity in sectors like road construction. “China now has a highway network bigger than [that of] the U.S.,” he said. “But it has 150 million vehicles compared to 250 million in the U.S. And this year, they’re still investing in building new highways.”

Xie’s own suggestion for tackling China’s economic woes, apart from allowing businesses in industries with overcapacity to shut down, is that the government should “cut taxes massively, by 3% of GDP or more -- whatever is necessary to boost household demand.” He says contributions to China’s welfare insurance system for employees take up “one-third to 40 percent of total labor cost, and therefore people’s income as a share of GDP is low, just 40 percent.” Xie says this deprives the economy of the very consumer spending the government always says it wants to promote.

In practice, there is unlikely to be one silver bullet for solving China’s current economic challenges, but there’s a growing consensus that the stock market may not, for the time being at least, be able to play the key role the authorities had hoped for. Even the official Global Times warned on Wednesday that amidst the current market instability, "ordinary investors will be better off being spectators."

Some experts are still hoping that China's market will undergo market-oriented reforms. If this happens, market forces, not government connections, will decide which new companies are listed. There is, not surprisingly, no clear timetable for such moves, and observers continue to wait for official policy to show greater transparency.