Six ways China has tried to remedy economic slowdown and shares slide

H/t reader M.G.:

“If this isn’t a recipe for disaster, I don’t know what is…..”

Six ways China has tried to remedy economic slowdown and shares slide (Guardian, Aug 25, 2015):

Governments can pull many levers to influence the behaviour of households, businesses and investors – Beijing has opted for half a dozen

China has tried to reboot its economy for the last year after it became obvious that a slowdown in early 2014 was turning into a steady decline in growth. Governments can pull many levers to influence the behaviour of households, businesses and investors. Here are the six main ones Beijing has used.

Cutting interest rates

The cut on Tuesday is the fifth since November and brings interest rates in the country down to 4.86% – an all-time low after having averaged 6.36% between 1996 and last year. The People’s Bank of China shaved another 0.25 percentage points off the borrowing and deposit rates to spur bank lending and encourage savers to spend the cash rather than earn a declining return on their money.

Reserve ratio reduced

China’s central bank took half a percentage point off the reserve requirement ratio, which governs how much money banks can lend to the economy. The move runs counter to the professed desire of Beijing leaders to restrict a property bubble that only a couple of years ago looked like wrecking the economy. As in the west, China has found that investment funds are increasingly channelled into property.

Currency devaluation

For many years Beijing came under fire for keeping the yuan low against the dollar to increase China’s exports. But in recent years the yuan has appreciated in value, especially against the dollar, euro and yen. A fortnight ago Beijing shocked investors when it embarked on a forced devaluation. It argued that the move was part of its liberalisation programme – freeing the currency a little from central control. To prevent panic selling, it then used its financial muscle to buy yuan and stop it falling further. This week the yuan is 4.6% lower against the dollar and, according to many analysts, heading for a 10% cut over the next few months.

Buying stock market funds

China now has more than 90 million individual investors, a constituency that’s larger than the membership of the Chinese Communist party. Cuts in interest rates and more relaxed lending rules introduced this year encouraged investors to storm the stock market, sending the Shanghai Composite index soaring by 150%. This bubble burst in June, and the spiralling market only came to rest after Beijing spent billions of yuan buying back stock and forcing state-owned industries to maintain cross-shareholdings. Beijing has spent about £130bn propping up the market, including over the last few days.

Liberalising pension fund investment rules

China’s state pension funds have held government bonds in their portfolios of investments, but until now, equities were banned. Then came the announcement at the weekend that allowed state funds to put as much as 30% of their assets into domestic stock markets. This is expected to triger a flow of investment cash into the Shanghai index, pushing values back up.

Cutting stamp duty

Stock market traders are always complaining they pay too much tax on transactions. Governments tend to want shareholders to increase in number and to hold their investment for the long term. In this context, stamp duty provides a tidy tax income and a disincentive to trading for its own sake. On Tuesday the People’s Bank said reforms, including a cut in stamp duty, were aimed at reducing “the social cost of financing to promote and support the sustainable and healthy developments of the real economy”. Analysts said it was a quick fix to bolster a falling stock market.

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