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China: Should we be worried?

January 2016

By Aberdeen Asset Management

Few starts to a new year have been so traumatic. A plunge in China’s stock markets twice triggered newly-installed circuit breakers within the first week of trading. Markets around the world trailed those developments as the panic spread further afield.

China matters more in the world than ever before and now its financial markets, despite their insularity, are also more influential. The underlying causes for the market rout reflect a combination of factors, some new while others are not so new.

Since China’s stock market bubble burst last year, authorities there have experimented with a mixture of rules, suasion and asset-buying to get the market to behave in the way they want. Simply put, this means getting – and keeping – share prices up.

But circuit breakers designed to soften the impact from the expiration of share lock-ups had the opposite effect to that intended, and only created panic. On January 7, Shanghai shares fell the 7 per cent needed to suspend trading for the rest of the day within the first half hour.

Circuit breakers are not unique to China. US regulators adopted them in the decade after markets crashed back in 1987. What Chinese policymakers got wrong was in making the thresholds that would trigger an intervention far too conservative. While 5 per cent and 7 per cent declines in share prices are rare in more established bourses, this is not the case in China’s volatile markets.

Policymakers may have been keen to limit the extent of daily losses, but each time trading was temporarily suspended at 5 per cent, this provoked a rush for the exit, making a 7 per cent decline and a trading suspension for the rest of the day almost inevitable. Regulators have since withdrawn these circuit breakers – a move that has calmed markets – in order to rethink their strategy.

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