Posted by Cognito on Thu, Jul 16 2015

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China’s stock crash not exactly a doomsday scenario

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While Greece was dominating international headlines over the past 2 weeks, China stock market looked set to be heading for a meltdown.

The Chinese stock markets, both Shenzhen and Shanghai, saw a total of 3 trillion US dollar in market capitalization wiped out over the last three weeks, representing 30% of the value of Chinese shares. As a result of the continued slump, at least 1,249 companies halted trading on mainland Chinese exchanges, accounting for 43% of total listings.

The market correction brought a halt to a long rally, where the Shanghai composite has risen +131.1% to its peak on 12 June 2015 since September 2014.

In a bid to restore market confidence, the government intervened in a few ways:

  • China Securities Regulatory Commission (CSRC) temporarily halted initial public offerings (IPOs)
  • CSRC also announced that holders of more than 5% of a company’s stock will not be allowed to sell their stocks for the next six month
  • China Securities Finance Corporate Limited (CSF) has offered 60 billion yuan (41.89 billion U.S. dollars) of stock-secured credit for 21 brokerage firms to buy back shares on the market, according to a Xinhua report
  • China Financial Futures Exchange (CFFEX) also raised the trading margin requirements to curb speculation

There has been much hype about the effects of a slowdown of the world’s second largest economy. Fears of a spillover have created doomsday narrative, with various reports comparing it to the 1929 Wall Street crash or the Dow Jones crash in 1987, where the Industry Average index plunged 22.6% in a single day.

Yet the actual impact might be less than one might expect.

Firstly, according to a July 7th note written by Qu Hongbin, HSBC Chief Economist for Greater China, it was highlighted that “the stock market wealth effect in China is smaller than many assume, as stocks represent less than 15% of household financial assets and equity issuance accounts for less than 5% of total social financing”. This reduces the risk of triggering widespread economic contagion as the stock market has lesser connections with the real economy.

According to Qu, consumption growth is driven primarily by income growth, not changes in wealth for the average household. Furthermore, most households put their wealth in cash and deposits — not stocks.

Secondly, the impact on foreign investors is also likely to be limited. According to a Reuters report, no Qualified Foreign Institutional Investor (QFII), a scheme that allows foreign investors access to its stock exchanges, holds more than 5% of a Shanghai or Shenzhen listed company.

Thirdly, the risk of global contagion is low due to the low correlation of the Chinese stock market with the other global markets, as argued by a piece of research from The Economist.

One potential reason is due to the strong capital controls in place to prevent speculative cash from going in and out of the country. This was a plight which plagued many countries like Thailand, Taiwan, Philippines and Hong Kong during the 1997 Asian Financial crisis which saw capital flight on an unprecedented scale. While these capital controls restricts access to the capital markets for a foreign investors, the barriers in place help insulate the Chinese economy from financial and other shocks coming from abroad, and also within.

More importantly, this situation also highlights the need for a diversified investor base, including foreign institutional investors that tend to have a longer term investment horizon. This might help weigh up against the increased volatility on financial markets from opening up its capital account.

Official data released on Wednesday showed that second-quarter Gross Domestic Product was up 7% compared to a year earlier, providing a little fuel for short term optimism. While it appears that the intervention has yielded some intended results and restored confidence in the market, the wariness amongst investors will probably continue for some time.

China, Cognito Asia, Equities,
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