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Liu Zhiqin: Circuit breaker suspended too soon

2016-01-14

By Liu Zhiqin    Source: China.org.cn    Published: 2016-1-13

 


The suspension of the new circuit-breaker mechanism just four days after its launch shocked most of the A-share investors.[Photo/Provided to China Daily]

 

Many Chinese economists and scholars suggested a "circuit-breaker mechanism" for China`s stock markets last year to follow the U.S. example in seeking to prevent future major turbulence like the one in July 2015 when the markets lost 20 trillion yuan (US$3.05 billion) in value. They hoped the mechanism, which was put into practice on January 1 this year, would better stabilize local stock markets by preventing a sudden, drastic surge or fall.


However, the first week of 2016 demonstrated the Chinese experts were too naive in regard to market volatility, especially the one that was so violent. Strangely enough, these same experts wanted to suspend the mechanism for fear that repeated circuit breaks would trigger uncontrolled panic in the market.


As a result, one mistake was piled on another. The circuit-breaker mechanism was suspended, although it perhaps offered the only chance, to correct and save the market.


At least three reasons can be cited to show that suspending the circuit breaker was a reckless decision, one that could actually stoke up fears and not calm them.


First, people have the right to inquire whether serious, scientific and empirical studies were undertaken before introducing the circuit breaker to China`s stock markets, and simulations were undertaken to test it before implementation. However, the market reaction showed there had been no such preparations; hence, hasty decisions nearly caused a disaster.


One is entitled to expect that a foreign practice should at least meet China`s own conditions before adoption. The U.S. has a far more mature market than China. Markets in the developed economies follow their own rules in value assessment and risk prevention. When introducing these advanced management skills to a new market, one has to fully consider adaptability as well as potential risks.


Second, the stock market storm in the first week of the new year tested the regulators` resilience, requiring deeper understanding of the factors behind the turbulence. Rumors flowed in via the "Shanghai-Hong Kong Stock Connect," messing up the mainland market and then escaping with a profit. Such unusual hot money influxes could have been monitored, since China still has fairly strict control on its foreign exchange account.


Domestic markets have already shown some resilience in fending off hot money, but huge chemical reactions are still inevitable when other destabilizing factors, such as unsound policies, join the game. That`s when major market damage will occur.


Third, it is obvious that recent Chinese stock movements have been characterized by caprice mingled with a revenge sentiment. Some elements are using the stock market as a means of confrontation. This will directly undermine China`s economic transition, and may affect the collective social sentiment.

 

The China Securities Regulatory Commission limited major shareholders from selling off their holdings too soon. The move shattered market confidence, so that the continuous fluctuation was a natural reaction.


Now that we are unsure if the fluctuation was actually the result of the circuit breaker, why did we suspend it so hastily? The decision was as reckless and hasty as the one to implement the system in the first place.


China did not have it in place when stock prices plunged in the second half last year, so that the current fall cannot really be blamed on the mechanism. So, what was the real cause?


We can be sure not everyone was happy about the circuit breaker mechanism when it was implanted, because it would greatly limit their room for arbitrage. Therefore, various factors posed challenges to the new market player. In the circumstances, we should have given it a long run so the market and the "newcomer" could have had more time to get along.


Unfortunately, we failed to persevere. In only a few days, the circuit-breaker mechanism blew a fuse, leaving a big trauma hanging over the future of China`s stock market. Investors are skeptical of the regulator`s capability, and the reliability of its future policies. When people are resentful about one policy, they could use the stock market to vent their dissatisfaction, and this would lead to further market manipulation.


The self-supervision and self-correction capabilities in a market take a long time to develop. When the circuit-breaker mechanism was triggered, we actually had opportunities to regulate the market, just by raising the threshold of the break point to firstly allow the market to repair itself.


The year 2016 offers plenty of opportunities and risks to the Chinese economy. In terms of risks, those from policies outweigh those coming from operations. One has to bear in mind that the economy may temporarily experience a glide through a power failure. Only when reforms are fully implemented, could such "powerless gliding" end with improvement, and that`s what we are looking for now.


If introducing the circuit-breaker mechanism was a small mistake, then hastily suspending it now is a huge error. These reckless regulatory acts not only dampen China`s image internationally, but also weaken international confidence in the Chinese stock market. If this confidence drops below their tolerance level, the Chinese market will face a worst scenario of isolation.


With or without the circuit-breaker, how can the Chinese stock market possibly develop this year?


Liu Zhiqin is a senior fellow at the Chongyang Institute for Financial Studies at Renmin University of China.


Key Words: stock   market   error  

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