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China’s stock market plunge: how did it happen?

China Flag/AFP

China Flag/AFP

Chinese stocks resumed falling on Tuesday despite the government unveiling an unprecedented package of measures to boost the flagging market after a spectacular bull run reversed course in June.

– Why did the market surge? –

China’s stock market surge started in late 2014 despite the country’s gross domestic product (GDP) experiencing its slowest growth in 24 years.

The borrowing fuelled rally began after China’s central bank cut interest rates on November 21 for the first time in more than two years, and the launch of a scheme linking trading between the Shanghai stock exchange and Hong Kong bourse.

The rally continued in 2015 with the benchmark Shanghai index climbing to the symbolic 5,000 point level in early June, driven higher by margin trading, through which investors only need to deposit a small proportion of the value of their trades, generating bigger profits — but also bigger losses.

When it peaked on June 12 it had risen more than 150 percent over the previous 12 months.

– Why did it fall? –

On the same day as the market reached its peak, China’s securities regulator said it would tighten rules on margin trading for individual investors. The following day, the China Securities Regulatory Commission (CSRC) also banned trading with funds borrowed outside the margin trading system.

When markets reopened investors started to take profits on worries of over-valued stock prices and increasing market risk.

The de-leveraging process soon became uncontrollable, resulting in Shanghai plunging almost 30 percent over three weeks. Market sentiment worsened as investors who traded on margin were forced to liquidate their stock holdings to make payment.

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– What’s being done to support the market? –

The Shanghai index plunged 7.4 percent on June 26 and the next day China’s central bank announced cuts in both interest rates and the reserve requirement ratio –- the amount of money banks must put aside.

The market regulator then announced a relaxation of margin trading rules and reduced stock transaction fees.

Soon after the government announced proposals to let social security pension funds enter the stock market.

The CSRC cut back on the number of initial public offerings (IPOs), then went a step further by halting them for the near future.

China’s central bank said it would provide funds through the state backed China Securities Finance Co. to “protect the stability of the securities market”, while the 21 largest brokerages said they would invest at least 120 billion yuan ($19.3 billion) in so called “blue chip” exchange traded funds (ETFs).

– What happens next? –

No one really knows and the market remains wildly volatile. Forced sellers could drive prices lower, or bargain hunters could see a buying opportunity and step in.

“With investors’ confidence towards the market shattered, it’s really hard to tell when it will start to stabilise and recover from recent falls,” Haitong Securities analyst Zhang Qi told AFP. He estimates that the benchmark Shanghai index may rebound to around 4,000 points in the next month.

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