(Yicai) Jan. 16 -- Following the Chinese stock market downturn, establishing a stabilization fund could be one of the lowest-cost policy tools for the nation to boost its economy and market confidence. The capital market decline follows a sharp rebound last September amid a prolonged adjustment period in the country's real estate market and a threat of increased US tariffs.

Establishing a stock market stabilization fund with a scale of CNY500 billion to CNY1 trillion (USD68.2 billion to USD136.4 billion), focused on buying during market dips and maintaining long positions, would bring three significant benefits for China and effectively complement the structural monetary policy tools introduced by the People's Bank of China last year.

Firstly, launching the fund would send a clear signal of the government's long-term confidence in the Chinese economy.

Given the property market's impact on the macroeconomy and adverse changes in the external environment, stock investors are feeling pessimistic, potentially deviating from rational behavior. For example, on Jan. 6, the United States Department of Defense added Tencent Holdings and several other Chinese firms to a list of companies allegedly working with the Chinese military. Tencent's stock price slumped shortly after, even though the game developer stated its business would be unaffected by the move.

In such circumstances, a government-funded stabilization fund would send a positive signal to investors, making the government's commitment to further economic stimulus more credible. This signal could help investors break out of the vicious cycle of pessimism and market decline, enhancing risk appetite and restoring market efficiency.

Secondly, a stock market rebound would improve social expectations about the Chinese economy and support aggregate demand through two mechanisms: the Wealth Effect, where people tend to spend more when they perceive an increase in their assets despite unchanged net income, and Tobin's Q Theory, which predicts increased corporate investment when company valuations exceed asset replacement costs.

After entering the market, the stabilization fund would likely encourage more investors to follow, promoting rising stock prices. The stock market serves as one of the most important leading economic indicators. Both investors and consumers reassess economic prospects based on recent stock market movements, thereby increasing investment and consumption expenditures.

Moreover, according to Tobin's Q Theory, when market valuations exceed the replacement cost of assets, firms are more likely to purchase new facilities rather than acquire other companies for expansion, thus boosting overall social investment.

Lastly, purchasing Chinese stock assets at low valuations has a high probability of generating good returns in the long run.

Currently, the Shanghai Composite Index's price-to-earnings ratio stands at just over 10, placing it in a historically undervalued range, making the stocks quite attractive. If the stabilization fund invests now, both corporate earnings and valuation levels are likely to improve once the economic cycle turns upward, potentially providing substantial returns for the fund.

Last September, the PBOC introduced two policy tools to boost the stock market: a swap facility for securities, funds, and insurance companies, and a re-lending facility for listed companies and their major shareholders for buybacks. However, these tools introduced limited liquidity due to insufficient market demand. Establishing a stabilization fund could inject a larger scale of capital into the market, effectively complementing the existing tools.

*The author is vice president and chief economist at JD.Com Group.

Editors: Dou Shicong, Emmi Laine