Carnage at the stock markets in China. But catastrophe may be avoided.

As the West awaits the
Greek referendum that will determine the future of the Euro, something more
ominous appears to be materializing in China. On Wednesday, the Shanghai Composite
Index fell below 4000, and after days of undulating fell again on Friday, wiping
out more than US$ 2.8 trillion of value after the June 12 peak. [1]
The sheer amount of Renminbi losses makes the Greek debt negotiation seem like
a quarrel over pocket money.

To prevent further bloodletting,
both monetary and state firepower came to the fore. Last weekend, People’s Bank
of China cut lending rates and the reserve requirement ratio. The Chinese
government also stepped in, freezing IPOs, unleashing the state pension fund to
buy up stocks, as well as easing rules on margin trading in an effort to stop
the vicious cycle of freefalling share prices and forced selling. The latter is
an ironic but crucial move since it encourages the very practice that was
behind run-up of the stocks.

Despite the resuscitative
efforts, the stock market has officially entered what many analysts would call bear
market territory. So how will this affect the world’s second most important
economy?

Already, huge amounts of
capital-raising opportunities are forgone and if the crash continues, it could
set off a doomsday chain reaction in a market dominated by margin trading. It
is also a setback for the Chinese government’s plans to move from debt-fuelled
growth to one based on sustainable stock market. A vibrant one provides
liquidity for companies to pay off debt, and can syphon funds to
capital-deprived small-cap tech companies on the Shenzhen market, helping China
to gradually discard heavy industry.[2]

That said, the impact of
the stock market crash may not reverberate too far, precisely because the skyrocketing
stocks earlier had less to do with actual economic activity. Remember, the
equity takeoff largely glided over a comprehensively slowing economy. Moreover,
the stock market is still just a small part of the economy, with free-float
capitalization of the stock market just 40% compared to the typical 100% in rich
countries.[3]

The rally may have made 1
million new millionaires[4],
but this has barely translated into a knock-on retail boom. Although mums and
dads conduct 80-90% of the trading, less than 7% of the urban population
actively trades in stocks, as pointed out by Andrew Batson, a long-time China
finance expert. Nor is it clear how much of an impact it has on companies.
During the rally, only 5 % of total capital raised by the private sector came
from equities. [5]

As Beijing blurts out
propaganda to restore the People’s confidence goes on a hunt for market
manipulators[6], the
current state of the stock market increasingly leans towards pessimism. But
optimists still maintain that bank shares—important indicator of the real
economy—have barely fallen in the midst of the forced selling.

 

 

[1]
http://www.bloomberg.com/news/articles/2015-07-03/china-s-stocks-plunge-to-three-month-lows-as-bear-market-deepens-ibmyo1o1

[2]
http://www.ft.com/intl/cms/s/0/fba2e7d0-1a43-11e5-8201-cbdb03d71480.html#axzz3ek86tdJv

[3] http://www.economist.com/news/finance-and-economics/21652337-economic-dangers-chinas-manic-bull-market-goring-concern

[4]
http://www.ft.com/intl/cms/s/0/fba2e7d0-1a43-11e5-8201-cbdb03d71480.html#axzz3ek86tdJv

[5]
http://www.paulsoninstitute.org/paulson-blog/2015/07/01/voices-why-chinas-market-crash-wont-kill-the-economy/

[6]
http://www.reuters.com/article/2015/07/03/us-china-markets-idUSKCN0PD03020150703

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