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China's stock market has taken a massive hammering today. Here's why...

The country’s government wants to put the brakes on debt-fuelled spending.

CHINESE STOCKS PLUNGED today after the country’s securities regulator rapped three major brokerages for continuing to lend money for stock purchases in violation of rules.

As punishment for extending so called “margin trading” contracts, the brokerages are forbidden to offer credit to new customers for three months.

At one point, the Shanghai Composite Index was down 8.3%, although those lossed were later trimmed to 7.7%, the biggest single-day fall since the financial crisis of 2008.

Share prices of brokerages were hardest hit, with some falling by the daily loss limit of 10%.

Despite the sharp fall, the Shanghai Composite Index is still up 55% in the past 12 months and up 33% for the past three months.

SSE The Shanghai Composite Index for the past 5 days Yahoo! Finance Yahoo! Finance

Why did the market fall so much?

Investors and analysts see the penalties against the brokerages as foreshadowing more curbs on credit-financed trading by China’s government.

Authorities want to stop the stock market’s boom over the past year from turning into a bubble that could damage the broader economy.

The Shanghai Composite surged 54% last year, partly because of easy credit that investors used to finance their trading.

Market selloffs can also become self-reinforcing as other investors sell because of fear they will suffer even greater losses if they do nothing.

Did other markets around the world fall too?

No. Even though Monday’s fall was particularly steep, investors in other markets are brushing it off as a situation peculiar to China.

The government allows only limited foreign investment in Chinese stocks and the country’s financial system is largely walled off to the rest of the world.

The exception was Hong Kong, where many Chinese companies have stock market listings. A bigger catalyst for global markets will come Tuesday when China, the world’s No. 2 economy, reports fourth quarter growth figures.

China Markets Eugene Hoshiko / AP/Press Association Images Eugene Hoshiko / AP/Press Association Images / AP/Press Association Images

What are market experts saying?

“Margin financing is simply overextended,” said Dickie Wong, executive director of research at Kingston Securities in Hong Kong.

Regulators want to “simply give pause” to the brokerages, he said.

“In the past, mainland investors had no clue on margin financing and short selling, but after China introduced these two ways to trade stocks, people became so happy because they can borrow money and just go all in.”

China Markets The floor of the Shanghai stock market AP / Press Association Images AP / Press Association Images / Press Association Images

Is the plunge a sign of bigger problems?

It shows problems on several levels. Stock markets should allow investors to discover the fundamental value of companies, and although all markets are prone to under- and overshooting due to herd psychology, China’s market is particularly off-course.

That’s partly because it is dominated by opaque state-owned companies. In their relatively short history, China’s stock markets have fluctuated in ways that bear no relation to economic reality.

Its latest problem is that debt has fueled the recent rise in stock prices. There are also signs of debt-related stress in other parts of China’s economy including property, which is undergoing a painful government-instigated slowdown.

One developer, Kaisa Group, recently missed a $23 million interest payment on a bond abroad, alarming investors.

Additional reporting Peter Bodkin

Originally posted at 11.13am

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Associated Foreign Press
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