How Bad Can China's Stock Market Get?

China's stock market experienced a short-lived rally this week, but it's done little to cheer up investors who've seen the value of shares fall by 50 per cent since last October. The crash came after six months of heady growth when the Shanghai stock index soared from 2,500 points to an all-time high of more than 6,000, and tens of millions of new investors rushed into the market. This year rising retail prices and tighter government controls on money supply, aimed at reining in inflation, have depressed share values; a glut of new listings and concerns about slowing export growth haven't helped. NEWSWEEK's Duncan Hewitt spoke to Stephen Green, senior economist for China at Standard Chartered Bank in Shanghai, to find out just how bad the situation is. Excerpts:

NEWSWEEK: Why did the market fall?
Stephen Green: The first thing is we had a very big bubble to start with, and so given inflation and slower growth, along with tightening high interest rates, controls on money going out of the economy and the fact that since last year companies have begun to sell their state shares and other previously nontradable shares—as well as the situation in the U.S.—all of these things freaked everyone out and that triggered the fall.

Has it affected the economic fundamentals in China?
The economy is not looking dangerous going forward. We're still going to get 9.5 percent to 10 percent growth this year. But given that we are slowing down and that's freaking people out a bit, the stock market is not the obvious place to be. Still, it's remarkable what's happened: you've got a 50 percent decline in the market, and there are no reports of social protest because of it.

Did the government take a conscious decision not to intervene in the market?
The regulator wasn't going to stand in the way of this fall because it was obvious that once the market decided to turn it's very hard to control. At some point the regulator decided to step in to try and calm nerves a little bit, and try to prevent it collapsing—by cutting stamp duty, for example—but really this was a case of managing the downturn rather than trying to prevent it.

In the past, the government has been quite interventionist. What means do they have at their disposal?
They can play with the trading tax, they can issue new rules on the nontradable shares being released, try to delay those—they've done that a couple of times. They can come out with editorials in the official media. They've slowed down IPO [initial public offering] issues, and the government can ring up fund managers and tell them when to buy and when not. But fundamentally it's a much bigger market now than in the past, so the government can't control prices.

How badly have the new investors who poured into the market last year been affected?
The other thing about the Chinese stock market, is you don't have margin trading—you can only lose what you put in, can't lose more, which is obviously a good thing—whereas in more developed markets, a bank [might say] I'll give you 10,000 pounds to play with. Here they don't offer that. Also, house prices have generally held up, so that supports household balance sheets.

Will people give up on the market?
I think a lot of people just sit and hold—they say, OK I've got these shares, I'm not going to sell at a loss, I'll wait five years. And what's changed since, for example, 1998 or 1999, is the development of the fund-management industry, which now accounts for 40 percent to 50 percent of China's market capitalization. So that's intrinsically a much more stable force than 10 years ago. Fund management companies have to hold about 60 percent of their money in equities, so that's a stabilizing force, at least up until the point where people start to actually sell off their funds; my understanding is that over the past couple of months the number of people selling their funds has increased.

Are some investors reassured by the fact that the market is actually no lower than it was, say, at the start of last year?
Certainly. It was at around 2,500 then [it's now around 2,800]. So we're back to where were a year or year and a half ago, it's not a cataclysm.

Do many investors still hope the government will intervene to prop up the market—say, for the Olympics?
Some people complain about the lack of action, but there's not much the government can do.

Will the lack of alternative investment channels help maintain interest in the stock market?
There are more choices out there [than a few years ago]. We now have structured deposits at banks, but certainly the choice is still limited.

What impact do you think the crash will have on the development of China's stock markets in the long term?
In the long term, with better companies listed, and better fund managers, the market will mature—give it two years and everyone will be back in again, I'm sure.