On Saturday June 27th, the People’s Bank of China (PBOC) announced an emergency round of stimulus programs. The central bank slashed interest rates by 25 basis points to 4.85% and lowered the one-year deposit rate by the same amount to two percent. In addition, the PBOC lowered the reserve requirements for some of the nation’s largest banks.
For the first time, regulators are also allowing state pension funds to invest in the stock market. Previously, the fund was only allowed to deposit in banks or invest in low-yield treasury bonds. Economists estimated that this new rule could add more than one trillion yuan to the Chinese stock market. (Source: China Daily, June 30, 2015.)
The measures sent Chinese stock markets soaring. On Tuesday, both the Shanghai Composite Index and the Shenzhen Composite Index each gained 5.5% and 5.7% respectively during the trading session. The moves represented their best one-day performance in six years.
The stimulus measures are a desperate attempt by Chinese regulators to stabilize the country’s financial system. Up until yesterday, the Shanghai Composite Index had plunged more than 20% in 11 trading days. The ChiNext Index, a board that follows the country’s fast growing technology sector, had lost a staggering 31% since June 11th.
The Chinese government had to save the stock market because too much was at stake. The past year’s rally had brought with it many financially illiterate investors. Some people were selling or mortgaging their homes to put money into the stock market. Moreover, large financial institutions had big stakes in the game.
If the declines had not been stopped, the effect would be catastrophic. A stock market crash would have enormous consequences for the nation’s highly-leveraged financial system. Analysts fear a wave of investor defaults could plunge the country into an economic recession.
“A drastic correction goes against the healthy and stable functioning of the stock markets.” a spokesman for the China Securities Regulatory Commission told newspapers. (Source: China.org.cn, June 30, 2015.)
Investors will be watching the stock market closely over the next few days. If equity prices fall further, it could push Chinese regulators into launching even more stimulus measures.