China Crisis –keeping ahead of unintended consequences

01 Jan 1970 1:00 am by Mark Dunn

Despite exerting considerable influence over a population of 1.2 billion people, the Chinese government may have learnt in recent weeks that all the power in the world does not enable it to manage its stock market, or indeed economy, to a perpetual state of growth.

A volatile environment

Despite three years of relative stability on the Shanghai Composite Index between 2011 and 2014 (when the index fluctuated between 2000 and 3000) the subsequent growth since the beginning of 2015 (to a high exceeding 5000 in June) has been followed by a fall of some 40% in the following eight weeks, culminating in a low of less than 3000 in late August.

That the recent falls in stock prices may have more to do with the high valuations placed upon Chinese stocks before the falls will be scant consolation for the many international institutional investors that were openly encouraged to invest in the market by the Chinese Government.

Regulation on the hoof

Over the past two weeks China's Government has done everything in its power to prop up prices.  However in so doing it has created a set of circumstances that are likely to put off many of the foreign investors that the Government was wooing less than six months ago. With new regulations aimed to prop up share prices being imposed on an almost daily basis, international investment funds are finding it increasingly difficult to operate freely in the market.

Initially the Government used central funds to try to prop up share prices and ordered state owned businesses to buy into the market.  More recently Beijing has imposed limits to the size of open positions in futures markets in an attempt to stabilise prices.  Investors owning more than 5% equity of a company have also been barred from selling stock at all.

All of this would make investment in China risky enough without the news that the country is also currently toughening up its corruption laws. Whilst the new legislation should be welcomed - it significantly increases the scope of bribery charges – it also removes specific monetary figures that trigger automatic punishments, replacing these with general phrases such as "large" and "huge". In other words, the goalposts could change at any time and companies face more uncertainty and risk when doing business in China.

Mitigating risk

Despite all of this, withdrawing from the country is not an option for many investors. As recently as December 2014 the IMF announced that China had become the world's largest economy.  With the biggest population of any country, sustained long term growth and a huge manufacturing output, China remains an attractive investment opportunity in the long term.

So what can financial institutions do to mitigate risk and run an effective business in China?  Whilst it would be cynical to say "stay the right side of whatever the Chinese Government is announcing today", the value of information and insight cannot be underestimated when investing in China.  It has never been more important to understand what is being reported, both by the official news agency Xinhua, and the other media.  Proactive monitoring of customers, partners and competitors should be a central function of any business in China.  This not only enables compliance and therefore reduces risk, but also ensures that the business understands the wider regulatory and cultural implications of government policy that may well have righteous aims but may also lead to unintended consequences for foreign investors.

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