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

China's stock market surge started in late 2014 despite the economy experiencing its slowest growth in 24 years/XINHUA

China’s stock market surge started in late 2014 despite the economy experiencing its slowest growth in 24 years/XINHUA

SHANGHAI, China, Jul 8 – Chinese stocks plunged again on Wednesday even as the government announced more measures to try 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 economy experiencing its slowest growth in 24 years.

The borrowing-fuelled rally began after the 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 and Hong Kong stock exchanges.

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 potentially exposing them to 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 more than 30 percent since the peak. Market sentiment has 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.

On Wednesday, the government said Chinese insurance companies will be able to invest up to 10 percent of their assets in a single “blue chip” stock, up from the previous five percent.

Separately, the state-backed China Securities Finance Co. will “increase” stock purchases of small- and medium-sized companies, with liquidity support from the country’s central bank.

As of Wednesday, the market regulator had suspended trading in more than 1,300 listed companies at their request to prevent further falls in stock prices.

What happens next?

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No one really knows and the market remains wildly volatile. Investors forced to sell 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.

What are the possible consequences?

Some analysts believe the stock market plunge may hurt the economy, the world’s second largest, and could spark social unrest though the single-party state keeps a tight grip on dissent.

There are estimates that stock trading activity added more than half a percentage point to China’s economic growth in the first quarter, and a slowdown in the financial sector could have a wider impact.

“The slumping Chinese stock market has raised concerns of systemic risks,” ANZ Banking Group said, though it added the stock rout had yet to become a crisis.

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