Chinese stock markets fell over 10% in the last 10 days, putting question marks over the recent bull run in the world’s second-largest economy. HT explains what it means for the rest.
Why have the markets fallen?
Experts are calling it the bursting of a “classic bubble”, which started inflating last year after the state-run Chinese media started calling the stock market performance a bull-run that could continue in 2015. This led to a lot of “risky” margin trading, which helped the Shanghai Stock Exchange Composite Index surge 150% in the year up to its all-time peak on June 12, 2015.
However, this year China’s economy started slowing down, with companies reporting less-than-expected profits. This triggered a sell-out and sent the markets tumbling down. Since, its peak in June, the SSE Composite has lost 30%, this equivalent to an almost 8,500 decline in the BSE Sensex.
What is margin trading?
Margin trading is the practice of investing in shares on borrowed money, primarily from a stock broker. The problem with margin trading is that in case the stock market goes down, the investor has to pay up for the losses.
There are more than 250 million trader accounts in China and 90 million retail investors – individuals like you and me -- most of whom were trading on margins. The situation was exacerbated when, to bolster the “bull-run”, the Chinese government lifted restriction on the number of trading accounts one person can hold, so people could have up to twenty accounts.
But why would state-run media back a possible bubble?
The Shanghai Stock Exchange and the Shenzhen Stock Exchange, the two biggest stock markets in China, primarily comprise state-owned enterprises. For instance, the top gainers of the year-long bull-run were all government-owned enterprises.
“Not all market rises are bubbles: Government policy and national strategy have fueled this rise,” state-run news agency Xinhua said in April, a time when the Chinese markets were gaining points frantically.
What is the Chinese government doing about it?
The government has since late-June tried to stimulate the market through everything from interest rate cuts to announcing investments of up to $500 billion from pension funds into the stock market. The government also relaxed rules for margin trading and banned shareholders with stakes of more than 5% from selling their shares for the next six months.
Is this helping?
For a while it did, with the SSE Composite Index regaining the 4,000 level in mid-July, but it has slid since then. The index posted its first gain in over 10 trading sessions on Tuesday, after news came in that authorities will crack down on short-term speculative trading.
How does this affect the Chinese economy?
The total tradable market capitalisation of the Shanghai and Shenzen stock exchanges is $6.5 trillion, which is only 36% of China’s GDP. In developed countries it is more than 100%. For instance, for the US, it is over 150%. Therefore, the monetary damages will not be significant.
Also, Chinese stock markets are dominated by speculators, or traders who invest in stocks with the motive of selling them when their prices increase. This is the reason why Chinese economist, Wu Jinglian, called the Chinese market as casinos. A Brooking Institute paper blamed the “weakness of shareholder rights” for the phenomenon. This means that the primary losers in the crash are retail investors, who are trading on margin. The evaporation of their savings will mean they will spend less -- there will be decrease in consumption, slowing the economy further.
Does decreased consumption in China have global effects?
According to the World Bank, China’s consumption of metals and coal surged to roughly 50% of global consumption, most of which is imported. It also the world’s biggest oil importer. This the reason why the stock market crash led to a slide in global prices of metals and oil.
Over and above these, China is the largest market for multinationals. For instance Apple’s revenues from the country stood at $13.2 billion, which is more than a quarter of its total revenues. Also, lowered consumption would mean that the European Union and the United States, which are the biggest exporters to China, might face some pressure on their trade balances. But since foreign ownership of shares on SSE is only 0.34% of the total value, the direct effects of the stock market crash will not be felt by global investors.
Does India need to worry?
On the whole, India will be benefitted till the prices of commodities decline, because we import these goods to meet most of our demand. For instance, the decline in copper prices will help reduce our import costs — our import dependency on copper is around 90%. This will help us in managing our deficits.
However, big companies such as Tata Motors, which owns Jaguar Land Rover, may feel a pinch as China is the fastest-growing market for JLR.