Policymakers that seemed to be making headway tackling financial system risks and pushing market reforms forward now seem ready to create a brand new structural risk where none had existed before. The choice to intervene in the stock market may damage efforts to reform the financial system as well as potentially create future risks.
The stated bailout at this point appears to be small, $19 billion USD (0.23% of stock market capitalization). The PBOC also announced it will "provide liquidity assistance" (no amounts specified) to brokerages via the China Securities Finance Corp., directing funds to non-bank financial intermediaries for the first time. The precedent is significant. The PBOC is now supporting brokerages. And, policymakers have set a line in the sand for stock market losses that may force them to take greater action going forward.
Does it make sense to bail out a stock market up 81% over one year? If you are concerned with stability above all else, then maybe yes. But, in bailing out shareholders, Beijing has created another perceived implicit guarantee for one more market, on top of credit and property markets.
The market correction will have limited effects on the real economy over the near-term. The stock market spectacular rise and fall is less than a year old and has had very limited effect on the real economy to date (see my blog posts:China's stock market surge by the numbers., and China stock market returns and the real economy. Just how disconnected?).
But, by backstopping share prices, Beijing has significantly damaged its efforts to force market discipline into the financial system. Reducing shadow banking activities, decreasing local government debt risks through the swap program, allowing firms to default and fail, slowly opening the capital account, and refraining from devaluing the currency have all been tough-love policies for the better. Intervening in the stock market is a setback to reforms.
China's potential reasons for intervening in the stock market seem plentiful.
- Beijing could be worried about consumer confidence. But, stocks are held by a small minority of the population. And, investors are probably postponing consumption spending in order to buy shares. A sharp drop in prices may convince them to stop.
- The bull market has made it easier for innovative service and technology firms, important sectors for China's future, to obtain funding. More share price declines jeopardize that funding.
- Beijing was probably in favor of an extreme bull market in order to allow indebted firms to swap out debt for IPO money. If IPOs dry up, access to non-bank financial intermediation is reduced.
- Beijing could be worried that wealth destruction for urban middle class households will cause problematic social instability.
Whatever the reasons, by backstopping the $8 trillion dollar stock market, Beijing has harmed efforts to force discipline on investors. Lack of market discipline, whether in the property market, wealth management vehicles, or other credit markets, is the primary source of many of China's risks and structural problems.
More guaranteed risk taking in the financial markets may have negative consequences in the long-term and could require more complicated and difficult policymaking to fix market distortions in the future.