The Western business press for the most part has ridiculed China’s intervention in equity markets as a retreat from the free-market orientation embodied in the government’s reform program. This misses the point: China’s market has suffered from a massive distortion all along, which the government is trying to correct through emergency action. That’s hardly the best way to go about the matter, but late is a lot better than never.
China’s main government pension funds own no equities. For the first time, the government offered pension funds the flexibility to invest up to 30% of assets in equities in a June 29 announcement, with a comment period extending until July 13. This is a measure that should have been introduced years ago, and the fact that it was promulgated in the middle of a market crash is a sorry measure of the Chinese government’s lack of experience. Without a strong institutional presence in the equity markets, 85% of market turnover is retail, and Chinese retail investors piled into the rising market with a good deal of borrowing–and inevitably piled out. As we noted yesterday, it’s like a stampede at a football stadium.
To introduce an institutional presence in the market by emergency diktat looks bad, but it’s the right thing to do. One US press commentary goes as far as to argue that China is putting its financial system at risk to save the stock market. That simply isn’t true: it’s shifting long-term assets of pension funds into blue chips, which is a long overdue change, and engaging in regulatory forbearance where margin lending is concerned, which is also the right thing to do.