China's latest bout of market volatility looks like an overdue correction. Falling shares triggered newly installed emergency brakes on January 4, the first trading day of the year, while the yuan hit its weakest point against the US dollar since April 2011. Fresh signs of an economic slowdown are feeding the jitters. But the turmoil is also a delayed reaction to the previous flawed efforts to prop up markets.
Under new "circuit-breaker" mechanisms designed to curb wild market swings, the seven per cent drop in the main CSI 300 index caused trading to be halted 90 minutes ahead of the scheduled close. Surveys showing weak factory activity doubtless contributed to the decline. The two-month slide in the yuan is another factor. On January 4, the People's Bank of China (PBOC) set the mid-point of the official exchange rate at its weakest level for four-and-a-half years. The offshore yuan, traded in Hong Kong, is near a five-year low.
But selling pressure also reflects past interventions. Last summer, Chinese brokers, state-owned companies and other institutions spent billions of dollars helping to prop up the market. Though the bailout was bungled, stocks eventually stabilised. The CSI 300 index ended the year up more than five per cent. The smaller Shenzhen exchange, which has fewer stodgy state-owned enterprises than its Shanghai rival, racked up a 63 per cent gain. However, the massive overhang caused by the intervention is now weighing on share prices.
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Yet the American currency's relative strength is a big reason investors are moving capital out of China. It's also a growing headache for Chinese companies that have dollar-denominated loans. Capital outflows, in turn, exacerbate economic tensions within the People's Republic. The correction in both equity and currency markets may have some way to run.
