Business Today

Bears in the China Shop

The recent unprecedented crash in the Chinese stock market has dented investor confidence.
twitter-logoAnanth Krishnan | Print Edition: August 2, 2015
Bears in the China shop
Illustration: Ajay Thakuri

China is waging an uphill battle to restore battered investor confidence after an unprecedented crash in the stock market wiped out one-third of its value - close to $4 trillion - in a matter of three weeks. While the stock market crash is unlikely to have a prolonged impact on the already slowing down Chinese economy, experts in Shanghai and Beijing say that a Chinese economy that is in flux will certainly have a bearing on the region on account of falling demand for commodities and an increasingly uncertain future for Chinese financing of overseas projects as banks at home begin to grapple with a new reality.

The crash in the benchmark Shanghai Composite Index - which fell on July 7 to a low of 3,507, down by a remarkable 32 per cent from a high of 5,166 on June 12 - prompted a panicked government intervention: a six-month moratorium on selling stocks for any investor who owned stakes of more than five per cent of a stock, coupled with a halt on trading for more than one-third of all listed companies who were faced with margin calls.

Overcapacity in manufacturing: Chinese workers at a textile factory at Hefei in east China's Anhui province
The collapse followed a record-breaking bull-run: only in November 2014, the Shanghai index was at 2,400 before a government-encouraged campaign to boost the market, in part motivated by a long-term plan to push state-owned enterprises to go to the market to address persisting debt problems.

"The bull market was a classic asset bubble," Oliver Rui, Director of the CEIBS-World Bank China Centre for Inclusive Finance in Shanghai, told Business Today. This was fuelled by a combination of government stimulus and "investor frenzy". "Unfortunately, highly-leveraged greedy individual investors hijacked this initiative," says Rui. As the government last month moved to clamp down on debt-fuelled margin trading, the sell-off began. "That is what caused the market to panic," he adds.

On July 8, a record 112 billion yuan (around $18 billion) was unloaded by traders, capping two weeks of losses. The government's intervention - which included directing brokerages to buy billions of yuan worth of stock and routing 260 billion yuan (around $42 billion) from the state-controlled China Securities Finance Corporation, besides enforced restrictions on selling - prompted a rebound on July 9, with the Shanghai index rising by five per cent.

Uncertain Future

The mini-rebound notwithstanding, China's stock market faces an uncertain future. For one, the government intervention has dented the credibility of a market already famous for its rollercoaster swings.

The Chinese stock market is somewhat unique in the predominance of retail investors. As much as 84.1 per cent of investors have account balances less than 100,000 RMB (Rs 10 lakh) and 10.39 per cent have balanced between 100,000 and 500,000 RMB (between Rs 10 lakh and Rs 50 lakh), says Rui. Many of the 90 million investors on the Shanghai stock market are new entrants, prompted by the bull-run of the past year.

Only six per cent of them have a college degree.

The consequence is a market that is not often the most accurate reflection of what is happening in the real economy. In November, when China was grappling with a slowdown - the government cut annual GDP targets for 2015 to seven per cent, a target that today appears increasingly challenging - the market went on a bull-run. Similarly, the current crash does not suggest that the situation of the real economy is just as dire, says Xing Houyuan, Deputy Director of the Research Institute run by China's Ministry of Commerce. "Some Chinese middle class have entered the stock market to pursue immediate benefits and returns," she says. "They have earned some money so more people now put their money into stocks. Fluctuations do not mean fundamentals of Chinese economy are not good."

"Irda may first mandate that all plans sold electronically be held in demat form. It can later be extended to all polices"

That is, however, true only up to a point. While the sell-off in Shanghai may be more a result of government tightening on margin lending - rather than a reaction to economic indicators - the problem for the government that its intervention may have made an already opaque market further skewed. The government's move to prop up the market has already likely dented China's ambitions of internationalising its yuan (or renminbi) and introducing broad financial reforms to address debt problems in the State sector.

Impact on Region

The wider fear is that the consequences of debt-fuelled trading could spillover to the banking sector. "At the moment, it is only the stock market that faces a systematic risk. If the market is not quickly calmed, the pessimistic sentiments will spill over to the banking sector, and eventually it could affect the real economy," says Rui.

"Some insiders believe a significant portion of capital used for margin trading actually comes from the asset management products issued by the banks. Some also believe that some entrepreneurs have invested in the stock market using operating capital. The crisis could slow down the speed of deepening financial reform including marketisation of interest rate and internationalisation of the renminbi".

Since China's financial market is relatively isolated, the impact on the region is likely to be limited beyond concerns in investor sentiment that have already been reflected in a number of Asian markets in recent days. However, if China's banking sector is pulled into the crisis, it will likely put a spanner in the spate of "going out" lending agreements that its banks have been encouraged to offer in the past year.

Last year, outbound investment from China for the first time exceeded foreign direct investment. With India alone, China signed $22 billion worth of agreements in May when Prime Minister [Narendra] Modi visited China.

Most of these were financing arrangements, such as from the China Development Bank for the purchase of equipment by Bharti Airtel and Adani Power, and from the Industrial and Commercial Bank of China (ICBC) for Bharti Airtel and Infrastructure Leasing & Financial Services Ltd for infrastructure projects.

Beyond the stock market, the Chinese economy is also dealing with the larger problem of overcapacity in several sectors. While economist Arvind Virmani, formerly chief economic advisor to the Indian government and executive director of the International Monetary Fund, suggests that reduction in excess capacity in manufacturing in China could actually aid the global recovery, Beijing has at the same time moved to export this overcapacity through its ambitious $ 100 billion "Silk Road" initiative.

Xing, of the Commerce Ministry think-tank, says that regarding the overcapacity problem, China's view is that this "production capacity is by no means backward so they should not be exceeded or eliminated, and if there is any need in the international market they have value".

For instance, the government is pushing new energy and solar firms, which are struggling at home because of low demand, to go overseas.

"We will upgrade our technology and industrial capacity so that we will transform our economic growth model, and at the same time transfer some competitive production capacity to countries along the Silk Road," says Xing. Whether they will be welcomed beyond China's borders is another question.

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