RCIF | Research Center for International Finance
Policy discussion No. 2015.001
China's Intervention Lessons
Yu Yongding
BEIJING – China’s stock market has been a hot topic since the summer, when a rapid rise gave way to a major plunge, triggering a global equities sell-off. The question now is what can be done to prevent further volatility.
To answer that question requires understanding how China got to this point. For years, with the authorities’ encouragement (or at least acquiescence), China’s securities companies spared no effort in pumping up China’s stock exchanges with fashionable financial instruments and practices, the sole aim being to realize capital gains from rising prices (dividends are rarely distributed). As a result, after years of poor performance, the Shanghai Composite Index soared by more than 100% in less than seven months, from 2,505 points in November 2014 to over 5,178 last June – a level that was not merited by China’s economic fundamentals.
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After the crisis struck, instead of recognizing the decline in potential growth and adjusting accordingly, the government remained implicitly wedded to an unrealistic target of 10% annual GDP growth. But, while the CN¥4 trillion stimulus package propped up growth temporarily, return on investment was deteriorating, because potential growth was already lower than actual growth. As a result, credit demand was relatively weak; in many cases, commercial banks had to persuade enterprises to accept loans, with a large proportion of the credit ultimately devoted to chasing assets in the capital market.
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China’s experience in recent years holds valuable lessons for the country’s leaders. With a more balanced approach to intervention that reflects those lessons, they could put China’s economy on a much more stable path. That said, as China undergoes structural economic transition, the stabilization potential of macroeconomic policy is limited. Without more fundamental reforms, even an impeccable macroeconomic policy mix would not work. Reforms take time, which means that China may need to brace itself for more troubles and a protracted period of slow growth.