Asia Centre

On 27 February last, "Black Tuesday", the two mainland Stock Exchanges which trade in stocks and shares, the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) experienced historic falls of 8.84% and 9.29% respectively.

The Chinese Stock Exchanges were at their lowest since 2001, yet they bounced back, following a 2005 reform. Growth was such that in recent weeks the authorities were talking more and more of a speculative bubble and of the need to calm things down. The fall at the end of February was China’s most significant since the death of Deng Xiaoping (1997). Even the rare blue-chip shares fell, as shown by the steel, car manufacturing, finance and oil sectors, as well the major enterprises such as China Petroleum, Minsheng, Baogang and Changjiang.

The movement in the Stock Market indices on 27 February 2007

Furthermore, and this is undoubtedly the most important point, for the first time in its history, the fall in stocks and shares in mainland China brought in its wake a fall on the other Asian Stock Markets. At the time, these markets seemed even to have been more seriously affected than China’s[1].

However, Chinese shareholders started buying shares again as early as the next day, 28 February[2]. Since then, the Chinese Stock Market has resumed its bullish trend: the SSE and SZSE had experienced a boom on March 6 and 7 and the SSE index was hoping to pass the symbolic 3000-point barrier again, as compared with the 2700-odd points to which it had dropped on Black Tuesday[3]. Then, quite recently, the market dropped back again, following fiscal measures introduced by the government aimed at reducing speculation[4].

This analysis is mainly based on three series of articles: the first is from Zhongguo Guoqing Guoli that were published prior to the crash. It already stigmatised the behaviour of shareholders as irrational and dangerous. The second series, which appeared in the Nafang Daily, is an on-the-spot analysis of the crash, with attempts to provide explanations. Finally, the third series, which appeared later, assesses the impact of the reforms (according to the 21 Century Business Herald) and the impact, especially of globalisation, on the operation of the Chinese stock markets.

The causes of the crash

On the day following the crash, the Nanfang Daily reported several possible interpretations for this fall, based on interviews with market experts. One analyst from Xingyye Securities put forward the theory of an "accident" (偶发事件). For him, the accumulation of profits ended up being too great, bringing the market down with it (利空).

-          For other analysts, it is all about a natural phenomenon (自然现象). The stock markets experienced good growth in 2006, and it can be expected that such growth should slow down today. The respective drops in the Hong Kong, Singapore and Taiwan exchanges are symptoms of this.

-          Another related interpretation is that of a correction (正常调整): as the SSE went past the 3000 point mark, the pressure on profits began to be too great, and confidence in even higher future profits led to a necessary correction. According to this logic, as the SSE should vary between 2500 and 3000 points, the market should have dropped again (instead of going back up, as it did since publication of the article being analysed here).

-          Other analysts believe that the reason for the 27 February crash is to be found in the excessive profits expected by the various investors. They define this crash as merely a normal consequence of the bullish market (牛市常态).

-          Finally, there is the interpretation which consists in seeing in the crash a willingness on the part of the government to slow down a growth that had got out of hand, in order to build up a healthy stock market. This is the theory of a deliberate slowing down (调低预期). Worth noting is the fact that one of the causes often put forward to explain the fall is the rumour about government action to reduce the amount of trading on the stock market. To illustrate this theory, one could cite the most recent fiscal measures aimed at reducing market speculation.

A market that is still immature

However, one article by Xiao Jun published a few weeks before the crash (in January) seems to give ex ante other reasons for the crisis.

It is based on academic literature dealing with the behaviour of investors to explain the workings of the Chinese Stock Market. Among the works used (and very roughly quoted) are those by Bikhchandani and Sharma (2000), Lakoshinok, Shleifer and Vishny (1992)[5], Scharfstein and Stein (1990). Xiao Jun refers to them to insist on the dangers of the mass behaviour pattern (here called "羊群行为", a sort of sheep herd behaviour) of Chinese shareholders. Such behaviour has two characteristics. It is driven by information (one would be tempted to say rumour, but the term is not used), without paying any attention to its quality (and therefore to its true value). As the shareholders cannot verify the information, they adopt a mimetic pattern of behaviour, acting in the same way as other investors. The investment funds are therefore driven by a search for short-term profit and move only en masse. Admittedly, this behaviour pattern enables the Stock Market to generate profits more quickly, but it also leads to the creation of a bubble effect[6].

Another problem is that investment funds have a virtual monopoly over the Chinese Stock Market. Witness the six enterprises Boshi, Southern Securities, Huaxia, Jiashi, Hu’an and Yifangda which alone have 40% of the shares held by funds.

The problem therefore remains that, in spite of the reforms of the past few months, the market is not yet mature. It remains encumbered by a still insufficient liquidity, policies that lack coherence, listed companies that are often mediocre, insider trading that is still all too common, a weak return on investment …

Is this a market tied in with the rest of the world?

Beyond the Chinese Stock Market’s lack of maturity, the thing that undoubtedly struck many Chinese is the international nature of the 27 February crash. This was the first time that a Chinese-based Stock Market shake-up had spread to financial markets elsewhere.

However, on the Chinese side, what the press picked up on was not the fact that the fall started in markets on the Mainland, but rather its international character. In other words, in what is a turnabout, some people seem almost to accuse the rest of the world for being responsible for the Chinese crash. Even the governor of the central bank, the reformer Zhou Xiaochuan, was also of this opinion, when he stated that globalisation was the cause of the crisis (球化致)[7]. For his part, the highly respected Shi Yinhong, of the People’s University (interviewed by Huangqiu Shibao), points out that the world is closely watching China’s growth, which creates a strong  interdependence. As for He Maochun of Tsinghua University, he regards China as an engine powering the world economy. The only ones to emphasise the disproportionate nature of this interdependence are researchers from the Chinese Academy of Social Sciences. They remind us that the value of the Chinese stock market is 1,000 billion dollars, that is, about 50% of GDP.  Conversely, the US Stock Market represents 130% of its GDP. The Stock Markets in Japan, India and South Korea each represent 100% of their country’s GDP. This ratio drops to 70-80% for South-East Asia. Hence, in their view, one must see China’s influence in relative terms.

What is in store for tomorrow?

Yet, the very next day investors started buying shares again, as if nothing had happened. The subtext of this was the idea that the authorities would not let a stock market crisis tarnish the 2008 Olympic Games[8]. At the present time, the Chinese stock market remains hard to predict…