The Chinese Dragon perhaps breathed out a little too much fire this time around that burned away its money and stock markets. In the first part I established how it was in fact the Chinese government which was to blame for this upheaval (if you haven’t, read the first-part first). As soon as the crash got out of control, the government began intervening directly into the affairs- perhaps getting a little too out of breath- which made the globe raise an eyebrow. Here are the measures that were undertaken to reduce selling activity and boost buying activity:
- The China Securities Finance Corp (read ‘the government’) is lending $42 billion to 21 brokerage firms so that they can purchase stocks and they have directed mutual funds and state pension funds to buy stocks.
- China has allowed about 1,430 of the 2,800 companies on the stock exchange to halt trading in their shares.
- Companies’ major shareholders — those with more than 5% of a company’s shares, as well as executives and board members — were banned from selling shares for six months.
- China stopped any new stock listings (IPOs) over the weekend so that less shares be available to be sold in the market.
- China’s central bank has cut rates to a record low in an effort to pump more money into the system (by making borrowings attractive) and has cut transaction fees on trading.
- China has practically banned short-selling- a way to sell your stock before you buy it when you’re expecting the price to fall. Understand it here.
- Most importantly: China’s securities regulator announced it would once again reduce the minimum collateral requirement for margin trading! (If you didn’t facepalm,you haven’t read the first post. Read the Causes now!)
So did these efforts work? Yes and no, both. Seeing the government panicking, the investors did too. And as before, 80% of the investors were small retail investors who had little knowledge about how markets work beyond just, “Hey look! People are making money buying stocks, I think I should too”. So these government measures in fact led to a greater fall in stock prices. But eventually people realised that the government is way too keen to get prices up and started believing that prices will, indeed go up. And they did: By Friday, the benchmark Shanghai Composite index had gained 5.1% from the previous Friday’s close. This is why the answer to the above question is yes. Let’s dig deeper. There are two reasons why the answer is ‘no’: the fairly obvious one – these controls will not last forever and the fact that the China is not an India or a USA (I’ll get to it in a second). First, the eventual reality. The government will obviously have to remove these controls sooner or later. The question then is whether China will be able to sustainably subvert the collapse once the short-term mitigation has run its course or not. There is no certain answer to this, but it’s definitely going to be extremely difficult. Once the controls are removed, they can’t be expecting to go back to margin trading. That would simply be delaying and aggravating the disaster a little more. The 80% lot of small investors -who basically are ordinary citizens from farmers to barbers- have lost most of their invested savings. Further, the people who had bought WMPs that indirectly funded these 80% lot of risky investors will also lose out due to their debts turning bad. (Read my post on shadow banking here in case you don’t know how WMPs work). With so many people losing so much money, the consumption expenditure in the economy is going to take a huge hit (Debatable,though). When people buy less, the other people selling see their incomes fall who in turn again consume less and so on and so forth. With less income generation, production takes a hit and it can slow down an already slowing economy even further. One way out might be to open up the market to foreign investors who currently due to strict regulations own just 1.5% of the total shares. This is also one reason why foreign investors weren’t affected due to the collapse which would then have had made it a global disaster. (Though it wasn’t completely confined to China. Getting there!) Second, the fact that Chinese communism makes its government an egoistic and paternalistic entity. Let’s read between the lines a bit. Communism cannot exist unless the government holds a hegemonic yet bona fide faith amongst the citizens. Communism in two simple words means “State first”. So much so, that in China there are heavy restrictions in many areas against free access to the Internet, freedom of the press, freedom of assembly, the right to have children, free formation of social organizations and freedom of religion. Youtube, Facebook and Twitter are all banned in China and instead, state-endorsed versions of these are in use. All of this to ensure unquestioning faith in the government and squashing any dissent against the State. Now as The Economist puts it:
Lost in all the drama about the stockmarket is that it still plays a surprisingly small role in China. The free-float value of Chinese markets—the amount available for trading—is just about a third of GDP, compared with more than 100% in developed economies. Less than 15% of household financial assets are invested in the stockmarket: which is why soaring shares did little to boost consumption and crashing prices will do little to hurt it. Many stocks were bought on debt, and the unwinding of these loans helps explain why the government has been unable to stop the rout. But this financing is not a systemic risk; it is just about 1.5% of total assets in the banking system. If economic stability is not in peril, why then the panic? The most compelling explanation is POLITICS. The government has staked much credibility and prestige on the stockmarket. When the going was still good, the official press was chock-a-block with articles about how the rally reflected the economic reforms that Xi Jinping, China’s top leader, was set to push. Li Keqiang, the premier, said repeatedly that he wanted equity markets to provide a bigger share of corporate financing—comments, from punters’ perspective, not unlike waving a red cape in front of a bull. The sudden end to the rally is the first major dent in the public standing of the Xi-Li team. The botched attempts to stabilise the market only make them look weaker, giving succour to their critics.
Turns out even if those measures work for now, the political implications of the fall having taken place in the first place are huge. The 30% fall was a market correction that was long in the making. Yet China didn’t want to show that its government was the reason behind this chaos, when clearly it was. Now in this scenario, once the government commits to higher stock prices, its prestige becomes tied up with the stock market’s performance. As per Vox, the larger problem is that the last week’s interventions have reiterated that political influence is still of paramount importance in Chinese capital markets. This means that the next generation of Chinese executives, entrepreneurs, and investors will spend less time trying to make their companies more productive and innovative and more time thinking about how to curry favour with the government in Beijing. In a democracy like India and USA neither can the government exercise such control as to bring its stock prices back up nor does it expect such non-questionable faith in the State. Moving on, let’s see how this crash affects the rest of the world especially India. Here are the major impacts:
China is one of the largest consumer of metals in the world. A slowdown in China or even a possibility of slowdown means metal prices free-fall (because demand for metals is going to reduce substantially). For instance, copper is trading at a 6-year-low. China is the world’s top copper consumer, accounting for 40% of global consumption. Further, China has resorted to aggressive selling to clear its inventory of metals and raise cash during these hard times. Despite this, it can also be expected that after the stock market crash, investors would want to park their investments from stocks to commodities especially Gold moving from here, which can again increase prices. But is there enough money left with the investors to even do that? Time can only tell that much. Indian metal-producing companies such as Vedanta and Hindalco have seen their stock prices dipping which led to the SENSEX dropping 484 points on Wednesday.Despite this India has a reason to cheer: Being a developing economy with large consumption of metals for infrastructure and SMART CITIES, the low global prices mean lower costs!
2) Automobile Producers China was a leading destination of Indian exports of automobiles. With slowing consumption, their demand will fall. Tata Motors shares declined 6.2% this Wednesday.
3) Oil Oil prices have anyway been very low this past year, to a large part due to slowing global consumption of oil. With demand from China also expected to dry up, oil prices might fall further. This is great news for India which relies almost completely on imports for oil. Oil is also a raw material for almost every industry. Therefore, low oil prices mean lower inflation, lower trade deficit and higher production and economic growth.
4) Indian exports China is likely to devalue its currency, which makes its exports more attractive (cheaper) and thereby is a shot at reviving the economy. (external consumption to make up for shortfall in internal consumption). Once it does that, exports from India might become less attractive to importers especially goods like mobile phones. Though this means that Indian imports of Chinese goods will also be good news, but the former beats the latter.
And that’s all folks. China always occupies an interesting place in global economics.To stay updated with what I write, follow my blog by tapping ‘follow’ at the right margin (for PC) or the bottom (for Smartphone). I’d love to hear your views and reviews on my article in the comments. Thank you for your time!