Why is China's stock market in crisis? | Business | The Guardian
Stock information listed on a mobile phone in Shenyang, north-east China. Photograph: Yang Qing/Xinhua Press/Corbis
What is happening in China?
Stock markets in China are tumbling. A three-week plunge has knocked about 30% off Chinese shares since mid-June. China’s securities regulator has warned of “panic sentiment” gripping investors, many of whom are individuals that have borrowed heavily to play the stock market.
Hundreds of Chinese companies have suspended dealings in their shares in a bid to arrest a frenzy of selling. The authorities have stepped in with various measures, including a surprise interest rate cut. But so far, their efforts have failed to stem the rout and some analysts say the moves by officials have only served to heighten alarm.
Investors and policymakers around the world are looking on with growing concern that turmoil in the stock markets will spill into China’s real economy, the second-largest in the world and a huge engine of global growth.
But weren’t China’s stock markets soaring just a few weeks ago?
They were. China’s stock markets had previously been among the highest performing in the world, and had hit a seven-year peak in the middle of June. The Shanghai stock market had surged more than 150% in 12 months.
Shanghai stock market
What was behind the dramatic rise in shares?
Investors have been piling in, encouraged by falling borrowing costs as the central bank loosened monetary policy.
Unlike most other stock markets, where investors are mostly institutional, more than 80% of investors in China are small retail investors.
The rise was also fuelled by a switch away from property investment following a clampdown by the government on excessive lending by banks. Laws liberalising the stock market also made it easier for funds to invest and for firms to offer shares to the public for the first time. The past six months have seen a record number of businesses listed on the Shanghai and Shenzhen exchanges.
Related: Chinese stock markets continue to nosedive as regulator warns of panic
Why did the market turn?
Analysts were already warning that the dramatic rise in China’s stock markets was driven by momentum rather than fundamentals. Stocks were looking wildly overvalued at a time when the Chinese economy was losing steam. As fears grew that the rise in many stocks was unsustainable, the selling started.
Even China’s bullish securities regulators admitted markets had become frothy before they turned down.
How could so many people afford to buy shares?
At the centre of the dramatic stock market slide are individual investors borrowing from a broker to buy securities. There has been an explosion in so-called margin lending. Under that system, the broker can make a demand for more cash or other collateral if the price of the securities has fallen – known as a margin call.
What is the problem with margin calls?
In short, the problem for China’s 90 million or so retail investors is that shares can go down as well as up.
Margin calls are in no way exclusive to Chinese markets. But the mix of investors is unusual compared with most global markets. As brokerages have lapped up people’s appetite for borrowed money and stock market bets, more households have become exposed to the risk of a stock market correction.
Regulators have cracked down on margin trading in recent months and the resulting falling share prices have triggered margin calls. If those margin calls continue, investors will have to offload other assets to come up with the cash they need.
What are companies doing?
About 1,300 companies have suspended their shares – almost half the market – in what analysts see as an attempt to sit out the rout.
Some companies have suspended trading because they have used their own stock as collateral for loans and they want to “lock in the value for the collateral”, said Christopher Balding, a professor of economics at Peking University.
What are the Chinese authorities doing?
Beijing has supported a series of market operations to halt the sharp decline, but each one has been criticised for failing to restore market confidence.
China has arranged a curb on new share issues and enlisted brokerages and fund managers to buy massive amounts of shares, helped by China’s state-backed margin finance company, the China Securities Finance Corporation (CSFC), which in turn has a direct line of liquidity from the central bank.
The central bank, the People’s Bank of China, said it would continue to work with the CSFC to steady the stock market.
The CSFC also said it would purchase more shares of small and medium-size listed companies – the firms that have suffered the biggest losses in the rout.
Related: China stocks tumble again after premier Li Keqiang fails to mention crisis
How worried is the government?
The rapid decline of a previously booming stock market has become a major headache for the president, Xi Jinping, and China’s senior leaders, who are already struggling to avert a sharper economic slowdown.
Analysts say the government sees the strength of the Chinese stock market as a sign of its own clout, hence all the attempts to steady the market. Mark Williams, of the consultancy Capital Economics, said: “China’s leadership has doubled down on its efforts to prop up equity prices, because it believes that its own credibility is now coupled to continued gains on the markets.” .”
Because so many of the investors in the market are individuals, the government will be acutely aware that deepening losses risk denting the real economy and even fuelling social unrest.
Then again, in a statement on the economy this week, the premier, Li Keqiang, failed to mention the deepening market crisis.
What is the economic backdrop?
China’s economy was already losing steam. Its GDP growth rate halved from 14% in 2007 to 7.4% last year. The next GDP figures in mid-July are expected to show the slowest growth since before the financial crisis.
In a sign of softening demand, imports have been falling in recent months. Exports have also eased off, despite government measures to stimulate growth.
But analysts are divided over the scale of the risk to the real economy from the stock market turmoil. They question the strength of links between the two.
Jasper Lawler, an analyst at CMC Markets, said: “It goes without saying that movements in the Chinese stock market don’t necessarily correlate to China’s economy. This applied on the way up when Chinese stocks rallied more than 100% in the space of a year while economic growth was the slowest in six years. This should also be the case on the way down; just because stocks are crashing, it doesn’t necessarily have a knock-on effect on China’s economy.”
Will this spill into other markets?
That is the worry. To cover margin calls, investors are having to sell other assets to raise money. Commodities such as copper and silver have fallen in recent days.
On top of that, there is the effect on investor sentiment from the Chinese sell-off and fears its real economy could suffer.
Hong Kong’s Hang Seng
The contagion is already being felt in other Asian shares, which slid to a 17-month low on Wednesday. Hong Kong’s Hang Seng index was initially resilient to the sell-off on China’s mainland markets, but has been falling and on Wednesday suffered its biggest one-day drop since October 2008: all gains since the start of this year have been wiped out.
Who is most exposed?
Asian countries have strong trade links with China, so stand to lose out if its economy is hit by stock market falls.
Beyond Asian markets, investors in Australia are also starting to feel the effects of the Chinese slump. Australian stock markets have sold off on the back of the Chinese market turmoil and falls in commodity prices. The worry is focused on Australia’s miners, because demand for Australian iron ore and coal will fall if the Chinese economy suffers. The Australian dollar is also under pressure and slumped to a six-year low against the US dollar on Wednesday.
Australia S&P index
Because China has been such an important driver of global growth, the worries spread beyond Australia. The FTSE 100, where several big miners are listed, has been sensitive to weaker economic news out of China in recent months. The British chancellor, George Osborne, used his budget on Wednesday to highlight the external risks to the British economy, which include China.
China is the UK’s sixth-biggest export market and exports to the country have fallen over recent months. British banks have also increased their exposure to China in recent years.
On the other hand, pressure from China’s slowdown on commodity prices could be helpful for those countries more reliant on imports and keep their inflation rates low. Samuel Tombs, the senior UK economist at Capital Economics, said: “The UK economy has little to fear from slower growth in China … The eurozone crisis is a much more pertinent danger.”
So how does the turmoil in China compare with the crisis in Greece?
Potentially, the stock market rout in China, with all the political, social and economic risks it entails, could turn out to be a much bigger threat to the global economy than the debt crisis in Greece.
Kathleen Brooks, the research director at the currency experts Forex.com, said: “The sell-off in Chinese stocks in recent weeks makes the volatility in European and US indices look like a walk in the park.”
Economists have said that even if the stock market has limited impact on the real economy in China, that economy was already slowing. There is a risk, they say, that China is heading for a “hard landing”.
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Why is China's stock market in crisis? | Business | The Guardian
