Troubles in Chinese Stock Markets – by Xiaoyan Zhou

Zhou-Xiaoyan-Rachel-206Xiaoyan Zhou, PhD student at the ICMA Centre, blogs about the recent volatility in Chinese stock markets and the effect of government influence on trading.

All over the news it was reported that Chinese stock markets crashed in the first few trading days of the New Year last week following the recent release of weak manufacturing data, which evoked subsequent declines around the world. Some attribute the collapse to the devaluation of RMB, some blame the introduction of the “circuit-breaker”, and others accuse the end of a ban on IPOs and sales of major shareholders. Even though the reasoning of these claims is different, they cast doubts on the effectiveness and efficiency of the Chinese government’s interference in the market.

Two interesting facts about the Chinese market help to give some clues. First, China’s largest businesses still remain in state hands, and the major shareholder of big Chinese firms is the state. Second, China’s market is dominated by individual investors (80%). This indicates that mass individual investors are minor shareholders and know little about the business operation or governance structure. The proxies of state shareholding are supposed to act on the state interest, however, agency theory, a dominant paradigm in the financial economics, argues that the agent often diverge from the principle’s interests and pursue their own.

This dilemma situation could give us some implications with regard to the problems of market governance structure, market monitoring and enforcement mechanism. Moreover, from a market process perspective, power differential arises from disequilibrium conditions and, from games of incomplete information perspective, moral hazard occurs under information asymmetry. As long as power differential and moral hazard exist or accumulate, the advantaged party with more information, sound knowledge and wealthy support, such as institutions, politically influential individuals and state proxies, will naturally exploit the disadvantaged party with little financial knowledge, less information and higher leverage, such as individual mass investors. Thus, the authority policies that hardly touch the ground of power differential and moral hazard can only work temporarily. What is even worse is that “in China’s stock market, the rules rarely apply to big investors, who treat price manipulation as a basic trading strategy” The Economist (Jan 7th 2016)

With Chinese foreign reserve remaining high, and the strong willingness of Chinese authority to readjust the market, the recent collapse may not lead to economic crisis in the short term. However, the temporary policiese such as blocking IPOs and share selling, and injecting taxpayers’ money into the market cannot help China get out of the trouble.

“The interference by the authorities is simply delaying the inevitable” Telegraph (Jan 6th 2016)

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