In 1996, when the Chinese stock market was rapidly surging the authorities knew exactly how to end the party: a sternly-worded editorial about the dangers of speculation in the People's Daily, the party mouthpiece, sent share prices tumbling.
More than a decade later, and with another bull market in full flow, the authorities have tried to use the megaphone again. Three weeks ago Zhou Xiaochuan, head of the central bank, head warned of a potential bubble. The response was a 3 per cent increase in the Shanghai market. Other similar warnings have also gone unheeded.
Facing a more complicated and self-confident society, the government has had to develop different tools to try to prevent exuberant retail investors from creating a stock market bubble.
The increase in share trading stamp duty announced yesterday is the most important of a series of administrative measures directed at equity investors that the authorities have been preparing in recent weeks.
Steven Sun, equity analyst at HSBC in Hong Kong, said: “The grand strategy is to gradually deflate the bubble but not to prick the bubble.”
Economists believe the authorities have learned from their experience managing the housing market, which two years ago was showing worrying signs of overheating, especially in some parts of Shanghai.
The response was a series of measures, including a capital gains tax and restrictions on foreigners buying property, which resulted in a slow-down in the Shanghai market but not a slump.
In spite of the 6.5 per cent drop in the stock market yesterday, many analysts believe it could be just a temporary pause in the flow of new funds into the market. Wu Gang, analyst at Oriental Securities in Shanghai, said: “We believe this is only a short term adjustment in a bullish environment and the good fundamentals of the market remain. How long this adjustment will last depends on the interaction between investors and the government in the next few weeks.”
If the heavy speculation by retail investors does continue, analysts expect that the government has a series of other targeted policies it can steadily introduce to cool the market. In the last month, the authorities have already partly loosened the rules that restrict overseas investment by Chinese funds and individuals and further relaxation could divert money away from mainland equities.
For the last year, the authorities have also been preparing for the launch of an equity futures contract. Some analysts believe it would help calm the market by giving institutions worried about retail-driven speculation a means of hedging their exposure.
Given that the authorities closely control the timetable for new share issues, they have another important tool to absorb liquidity in the market. One option is for large companies such as PetroChina and China Mobile, which are only listed in Hong Kong at the moment, to be slated for a domestic share offering.
The other is for other state-owned companies listed in Shanghai to begin selling more shares in the market while still maintaining state control. Given the high valuations in the mainland market at the moment, many companies would probably be willing sellers.
The most potent weapon would be the introduction of a 15 to 20 per cent capital gains tax on share trading, rumours of which have been circulating since February, at about the time of the dramatic one-day fall in the Shanghai index. Officials would be reluctant to take such an option, however, for fear that it would provoke a market collapse.
Jun Ma, chief economist for China at Deutsche Bank, warns that if the market ignores the measures and continues to rise sharply, “the government will likely further increase the stamp duty, and we cannot rule out the possibility of eventual implementation of a capital gains tax.”
Aside from measures aimed directly at equity investors, the authorities could also try to use monetary policy to limit the amount of liquidity shifting into the stock market. Earlier this month, the government hiked interest rates and raised bank reserve requirements on the same day, an exercise that was partly aimed at the stock market, although it had little immediate impact.
With inflation also picking up in China, partly due to higher food prices caused by a disease that has killed millions of pigs, some analysts see further interest rate rises as inevitable. Hong Liang, an economist at Goldman Sachs, said: “We maintain our forecast of two further 27 basis point interest rate hikes for the rest of the year amid rising consumer prices and asset inflation”.
B Frank Gong, head of China research at JP Morgan in Hong Kong, said monetary policy was the wrong way to try to cool the stock market. “We have long argued that more targeted measures – rather than macro measures such as raising interest rates or tightening monetary environment by hiking reserve requirements – should be used to deal with the A-shares problem.”
