Fearing a full-blown stock market crash, the Chinese government scrambled to halt the steepest plunge in the Shanghai stock market in decades by rolling out a series of measures that observers say look increasingly desperate.

 

At the weekend, the country’s biggest brokerage firms announced a state-backed plan to buy massive amounts of stocks, while the government went to orchestrate a halt to new share issues. Numerous companies declared over the weekend their intention to scrap their initial public offering plans. Halting IPOs encourages investors to keep their cash in existing stocks.

 

Meanwhile, the government-controlled Securities Association of China said that 21 big brokerage firms had agreed to set up a fund worth at least 120 billion renminbi (US$19 billion) to buy local shares.

 

These measures, along with China’s surprise interest-rate cut and its go-signal for pension funds to buy stocks, are considered by some the most radical intervention yet in China stock market’s history.   

 

They are likely to prove controversial: while there are no guarantees the measures will be enough to calm markets and protect millions of small-time investors – who not only invested huge savings in stocks, but also borrowed heavily to buy shares – they had effectively put the soundness of China’s stock market at risk by going against the market.

 

Could China have flouted its own capital markets reform agenda by actively intervening in the stock market? 

 

The prospect of disappointing millions of households that got into debt buying shares is appalling, but what truly frightened Chinese policymakers was the enormity the market’s impact would have on the balance sheets of banks, brokerages and other financial establishments. Given the structured products and margin trading businesses banks and brokerages have been involved in, these institutions are potentially on the hook for billions of dollars’ worth of bets tied to the stock market.  Because of this, the government can’t risk allowing the Shanghai Composite Index to fall through the all-important 3,500 point level – a level at which many bets are tied to.

 

If the market had slipped further, there could be continued selling of mainland shares in response to margin calls. Should stock prices fall further Monday, creditors who lent investors money to buy shares would be prompted to call in their margin loans, which would then mean further selling to repay the loans. The 30% slump since the peak on June 12 already wiped nearly US$3 trillion in market value across A shares in under a month.

 

Shen Tao (沈韬), chief investment officer of Prairie Asset, a Shanghai-based private investment firm, believes a market crash could have far more serious consequences, “a chain reaction” that could mean massive capital outflow and renminbi depreciation. It remains a threat to China’s overall financial stability.

 

The Shanghai market, which on Friday had plunged over worries about margin calls, reacted with relief to the news of the measures. The Shanghai Composite Index (SCI) gained 2.41% to close at 3,775.91 points on Monday.

 

On Sunday, the government said it will provide liquidity to the market through China’s state-backed margin finance company, which can get direct help from the central bank. Some observers say the move was reminiscent of the resolve the Hong Kong Monetary Authority (HKMA) demonstrated in supporrting the Hong Kong stock market during the Asian financial crisis.  

 

The Hang Seng Index (HSI) lost 27% from October 22 to 28 in 1997, and further dipped to 6,660 points on August 13 1998.

 

The Hong Kong government intervened in the local stock market to deter currency manipulation by punters that built up large short positions in the Hang Seng Index futures. The government reportedly bought US$15 billion worth of shares in companies, nearly 13% of its foreign reserves in the process. The HSI climbed back to 14,000 points in July 1999.

 

Market experts say the Chinese government is doing something similar, defending its markets and its economy. While a major concern is that the measures announced still may not be the last, for now at least, China has halted a slide in share prices.