HONG KONG -- June was supposed to kick off a new era for China's markets.
The month began with the first-ever inclusion of domestic Chinese stocks in MSCI's regional and global share indexes, a move that was expected to bring a boost worth billions of foreign dollars into China's markets. Instead, steady declines have seen the Chinese market officially enter "bear" territory -- falling 20% below its last peak in January.
Thursday, the benchmark CSI 300 index closed down 0.9%, bringing its fall for the month to 11.1%. The yuan, meanwhile, slipped a further 0.3% in onshore trading against the U.S. dollar to 6.625, its weakest level since December.
Behind the slump is a confluence of anxieties about slowing domestic growth momentum, tightening financial conditions and the prospect that the trade confrontation between U.S. President Donald Trump and Chinese President Xi Jinping could deepen.
Concerns about a trade war with the U.S. have particularly weighed on Chinese companies which get a high share of their revenue from the U.S. Consumer electronics producer TCL, one of the worst performers this year on the Nikkei Asia300 index, has been hurt by worries that Trump's tariffs would hit sales of its flat-screen televisions hard.Telecom equipment maker ZTE, singled out for U.S. punishment related to its dealings with Iran and North Korea, has fared even worse.
But Trump cannot claim full credit for China's market swoon. Much of it relates to concerns about domestic financial conditions.
"Financial conditions have tightened amid stricter regulations, especially concerning shadow banking," wrote Frederic Neumann, co-head of Asia economics research at HSBC, in a Wednesday research note. "Funding has been getting tighter all around."
The tightened conditions are the result of Beijing's drive to control rising debt levels and related financial risks. This has seen, for China, a relative surge in corporate defaults. Gregory Suen, Asia-Pacific fixed income investment director for HSBC Global Asset Management, said this week that the pace of defaults is likely to quicken. "We expect the situation to continue in the second half as lower quality issuers see higher and more difficult refinancing needs," he said.
Amid the rising defaults, companies are struggling to issue new debt, with net corporate bond financing declining last month for the first time in a year, according to Northern Trust.
The financing difficulties could reverberate further. As noted by Gavekal Dragonomics China Economist Chen Long, about 10% of all Chinese domestic shares have been pledged as collateral for bank loans. With share prices falling, banks are likely to issue margin calls and then sell the pledged shares of borrowers lacking cash, further pressuring the market. A similar dynamic came into play during China's 2015 market plunge -- before the authorities intervened to discourage stock sales and organize mass share purchases.
Many see Beijing as more reluctant to intervene this time. "Beijing is committed to the financial derisking campaign, listing it as one of its main policy objectives for the next three years," Chen wrote in a research note last Friday. "Any retreat from this commitment would damage the government's credibility."
Many Chinese companies tried to duck the 2015 market plunge by suspending trading in their shares. MSCI cited this maneuvering in repeatedly rejecting the inclusion of domestic Chinese stocks in its indices; with MSCI having finally accepted Chinese stocks but warning it may kick out those which toy with trading suspensions, companies will likely be reluctant to test the index company's patience.
Michele Mak, Asia-Pacific equities investment director for HSBC Global Asset Management, said Tuesday that solid corporate earnings are hopeful signs however."Despite being a target of U.S. trade protectionism, investors should also recognize that China has transformed to a domestic demand-driven economy," she said. "Industrial upgrading is now a key earnings driver for China. Changes are happening not only in manufacturing sector, but also the services sector, including finance."