Implications of China’s Stock Market Crash

July 29, 2015 Updated: July 29, 2015

News Analysis

Using extreme measures, the Chinese regime eventually managed to stabilize the stock market crash that started in mid-June, during which both the Shanghai and Shenzhen stock market indices fell more than 30 percent in three weeks.

While many retail investors have begun to show signs of relief, even expressing gratitude to the government for “saving” the stock market and their investments, the episode has a very different meaning to foreign governments and investors alike.

Most importantly, it reveals that China’s stock market is still at a very premature stage, and the Chinese authorities’ inclination to exercise control is overwhelmingly strong. Many analysts and international media are beginning to cast doubts on the future direction of China’s economic and financial reforms.

In recent years, China has made great efforts to liberalize its stock market. Reform measures have been implemented, such as the gradual introduction of Renminbi Qualified Foreign Institutional Investors (RQFII) to participate in the A share market, as well as the launch of the Shanghai-Hong Kong Stock Connect last November that allows investors in each market to trade shares on the other market.

China has never shied away from its aspiration to transform Shanghai into a regional or even international financial center.

However, the meltdown of the stock market and the regime’s drastic responses—which include banning any new IPOs, prohibiting major shareholders to dispose of their shares within a 6-month period, and allowing listed companies to suspend trading without any valid reasons—have undoubtedly damaged the confidence of international investors.

Unlike the more mature stock markets, China’s stock market is dominated by retail investors who have little investment knowledge and experience.

Increasing the participation of institutional investors, particularly from the West, will be an important step for the market’s further growth and development. The pace of such reforms will definitely be stalled in the aftermath of the stock market crash.

Another of China’s important financial goals is the internationalization of the yuan. According to the International Monetary Fund (IMF), the opening of its capital account might help Beijing meet IMF’s criteria to join its Special Drawing Rights currency basket, which would greatly enhance the yuan’s popularity and status.

Yet again, one possible consequence of the stock market turmoil is that China’s chance of success in this endeavor might be compromised.

What lessons the Chinese authorities have learned and what direction they choose will be the focus of international attention.