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Chinese Stocks Plunged, What Happened?

On June 12, 2015, having just scored another new high at 5,178, The Shanghai Stock Exchange Index (SSE) suddenly fell.. and continue to fall until reached 3,383 on July 9, or dropped more than 30% in just less than a month! The stock index were dropped so quickly, to the extent that investors from around the world, including from Indonesia, raise the question: What is really going on in China? Is it true that there was a crisis?

Actually, if not because of the regulation from the China Securities Regulatory Commission (CSRC) that a stock can only go down for a maximum of 10% in one trading day, the SSE should have dropped even lower. On Wednesday, July 8, almost half of the shares on the SSE (and also in Shenzhen) were suspended from the trading, as their decline has reached 10%. Now imagine: If there is no such regulation, where the shares in SSE may dropped by 25% in a day just like ever happened in certain stocks on the Indonesia Stock Exchange, then what would happen?

Although seem alarming, but if you've analyze the movement patterns of SSE since the very beginning, in this case since last year, then you probably already predicting that the stock index would fall sooner or later.

Because, from exactly a year ago (July 2014), the SSE suddenly rose steadily from 2,000 to eventually penetrate the psychological level of 5,000 in early June 2015, an increase of more than 150% in just eleven months. Interestingly, the remarkable increase was achieved precisely when the country of China experienced not-too-good economic fundamentals, where the economic growth in the first quarter of 2015 was only 7.0%, the lowest since 2009, partly because of 15% decline in the value of exports.

And when a stock index in a country rose significantly (or in this case, extremely) without supported by economic fundamentals of the country concerned, then it means? Bubble, of course. Since last April, when SSE continues to rise relentlessly, there have been many posts on the internet warned about the indications of bubble, or even in this case no longer 'indications', because the bubble looks very real. I mean, how could you say that the Chinese Stock Exchanges were at their ‘fair’ level, when one of the five stocks is priced at.. 100 earnings???

The question, what caused the bubble? Well, the answer to that question may vary. But one thing for clear, on March 11, 2015, the People's Bank of China (China's central bank) announced at least two stimulus for investors in the capital market of China, namely: 1. Cutting the benchmark rate (just like Indonesian BI Rate) to 4.85%, the lowest in history, and 2. Support for the granting of loans to investors in the stock market, including for investors who just opened their stock trading account for the first time.

Logo of Central Bank of China

The two policies allowed the investors to borrow funds from banks or brokerage firms in large amounts and at low interest rates. And the result is just as predicted: Many investors take so much loans to buy stocks. As of April 2015, the loan value of investors in Chinese Stock Exchanges reached US$ 269 billion in total, up three-fold compared to the previous year. When everyone has a lot of money (even though it does not belong to them), they continued to buy shares, so as a result, the SSE continues to rise.

So now you know, what caused the drop of SSE: Margin call. When the price of a stock began to fall to a certain extent, the investors who bought it using the loan/margin money will be required by the brokerage firm to deposit additional funds, to cover the amount of losses that might occur. If the investor can not deposit additional funds, he would forced to sell his shares at any price (even though the price is very low). And when there were a lot of investors who sell their shares at once, then that’s it: SSE plunged 30% in less than a month.

Okay, so is it true that the Chinese economy is in a crisis? Is it true that the crisis is more severe than Greek’s? Actually, not at all. In above I already mentioned that China's economic growth is slowing, but the conditions are still far from the crisis. To give you an idea, here is the data of Chinese macroeconomic compared to Indonesia (which started to cough), and Greece (which had entered the Emergency Room). Note that in terms of economic growth, the unemployment rate, up to the amount of debt-to-GDP ratio, unlike the Greeks that were in a bad condition, but Indonesia are better, and China are just fine.

Country
GDP Growth
Interest Rate
Inflation
Jobless
Debt/GDP
Cur. Account
China
7.0
4.9
1.4
4.1
22.4
2.1
Indonesia
4.7
7.5
7.3
5.8
25.0
(3.0)
Greece
0.2
0.1
(2.1)
25.6
177.1
0.9

So the decline in Chinese Stock Exchanges was purely a market fluctuation, and is not directly related to the performance of the listed companies or the macro-economic conditions of China. In fact, while down significantly in the last month, but from year to date, the SSE is still up about 8% throughout 2015.

But because the magnitude of the decline was extreme, then there is a worst possibility: If the investors fail to pay their debts even after they have forced to sell their stocks, it could cause the banks and/or brokerage firms that provide the debt, to also be default. These conditions had occurred in the US back in 1929, where dozens of banks were not able to collect the payment from the their debtors, until they could only raise their hands when the customers come to withdraw their savings/deposits. And when these banks went bankrupt, then that's the beginning of a period of great depression in the United States in the 1930s, which is still remembered as the worst economic crisis of all time.

However, although the investors in China began to suffer huge losses, but so far there is no news that there are investors who failed in paying their debts. And the Chinese Government itself did not stay silent but launching ten policies/regulations to address the problems, namely:

  1. The Government of China, through the China Securities Finance Corp. (CSF), will lend at least US$ 42 billion to twenty-one brokerage firms, so they can buy blue chip stocks in SSE and Shenzhen Stock Exchange.
  2. CSF alone will directly buy the shares of small and medium enterprises in the Exchanges.
  3. The Government will provide a cash stimulus of US$ 40 billion, which will be distributed to certain areas in the mainland that are considered in need, to promote the economic growth.
  4. The government will spend more on infrastructure.
  5. The China Securities Regulatory Commission (CSRC) has allow more than half of the companies listed on SSE and Shenzhen Stock Exchange to suspend the trading of their shares, so that their share prices won’t go down any further.
  6. The CSRC also banned the majority shareholder of all companies in the Stock Exchanges for selling their shares, for at least six months ahead.
  7. The CSRC cancelled all plans of IPO, at least for now.
  8. China's central bank will again lower the interest rate, so that there are more funds to be pumped into the market.
  9. The regulations for stock investors to apply a loan/using margin funds will be loosened. For example, investors may offer the housing certificate to the brokerage firms as a collateral to obtain loans. And
  10. China's central bank will lower the value of the Yuan against the US Dollar, which is expected to enhance the value of Chinese exports.

So now, will these policies be able to re-raise the SSE index? Well, we'll see. But frankly, I’m just worry. As we have discussed above, the cause of the fall of the Chinese stock exchanges have actually been very clear: The presence of government policies, in this case the Central Bank, which caused almost everyone to buy shares using debt, and eventually causes the bubble (and the bubble is already starting to burst in the last month). Then why the Chinese government is now even providing larger debts? Does not that mean that the government is only delaying the bubble to not burst now, but in the end it will lead to larger bursts someday???

So I just hope that there is something that I don’t know about this, and the Chinese Government's policies are actually sound. Only, indeed, if the worst happens, then the Indonesian economy including the Jakarta Composite Index (JCI) will inevitably be affected. As you might understand, the Greek Crisis has no any direct effects to Indonesia, except the psychological effects. But if China were in a crisis? Well, that means game over.. When the coal prices continued to fall, it caused a decline in the value of Indonesian exports and ultimately reduce national economic growth since 2011. And the cause? The declining demand for coal from China, one of the main export partners for Indonesian coal and also for many other commodities.

However, I think it is still too early to guess about what is going to happen with the Chinese stock exchanges and economy in the future, including its effects to the JCI and Indonesian economy. But clearly, if we look at the economic conditions in the field, it is difficult to say that the period of second quarter of 2015 has been better than the first quarter. I mean, when the Indonesian economy grew 4.7% in the first quarter, in the next second quarter the figure may be even lower. And that, of course, will be a negative sentiment for the JCI, even if the Shanghai index was able to recover.

Any inquiries about investment in Indonesia Stock Market? Please send an email to teguh@averepartners.com.

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