Traumatic Tuesday at the Shanghai Stock Market

The move by China’s central bank on Saturday 7 June is the fifth time this year that the central bank has raised the reserve requirement, which now stands at a historically high level. With the stock markets in Hong Kong and China being closed for a holiday on Monday, the market reaction to this move by the central bank became clear when the markets opened on Tuesday. At the close of business, the Shanghai composite index was 3,072 points – the lowest since March 2007.

In the not too distant past, China’s stock market was on a dramatic upswing. In October 2007, the Shanghai composite index rose to 6,092 points – a record high. During the following six months, however, it fell by nearly 50%, leading to investors voicing their discontent with the situation. In late April 2008, in what was seen by many as a reconciliatory gesture, the government of China cut a stock transaction tax. This move went a long way to restoring investor confidence, with many believing that the downturn was over.

However, the earthquake affecting mainly the Sichuan province and the struggle to return some sort of normality to the region, coupled with ongoing inflation concerns in China as well as other Asian countries, has resulted in a negative outlook among Chinese investors. As in many other parts of the world, higher food and energy prices are the main factors in pushing inflation levels up, although prices of other commodities have also shown a marked increase.

Tuesday’s sharp drop took many investment analysts by surprise and some feel that the market is overreacting. It is widely recognized, however, that the Asian market, as with markets elsewhere, is currently very volatile.