But Beijing will fight to protect its stock market
It is too early to gauge the full impact of the Chinese stock market meltdown earlier this week but one thing is clear: The crash is an early indicator of deep-rooted problems in the Chinese economy and some of the challenges that Beijing will be facing, as it seeks to update the country's economic fundamentals. The current meltdown has been in the works since June 12 but, it wasn't until Wednesday, when the market took another major dive, that the world took notice. Since June 12, more than three trillion dollars have been wiped out altogether from China's two main stock exchanges — that's about double the value of the Indian stock market.
Continued losses over three weeks prompted at least 1,300 companies to suspend trading on Wednesday, which helped stem further losses. Finally on Thursday, the Chinese stock market made some significant gains. This was equally the result of several damage control efforts by the Chinese Government, including lending $42 billion to 21 brokerages so that they'd buy blue-chip stocks, prohibiting state-owned companies from selling their shares, allowing investors for the first time to use their houses as collateral to borrow money to buy stocks and cutting interest rates for the fourth time this year. Many believe that the Government over-reacted. Stock markets rise and fall all the time, and even this three-week downfall only erased about 30 per cent of the market gains since mid-2014.
This brings us to the meteoric rise of the Chinese stock market. In just 12 months, the market created an astonishing 6.5 trillion dollars of value. However, in the ‘real world', the Chinese economy has not been growing fast enough to legitimise this surge. The Chinese stock market is now arguably the biggest bubble since the dot com boom. This bubble has been primarily fuelled by ‘margin loans' — wherein investors borrow money from stock-brokers to buy stocks. Margin trade has been rampant in China since 2010, introducing greater instability in the market.
Another factor fuelling the surge is the slump in the real estate market. Housing had been the average Chinese person's preferred investment avenue for decades but when the sector plateaued in 2014, many turned to the stock exchange for assured returns. It is estimated that many of those worst hit from the crash are young, first-time, small-time and less-educated investors. This is unlike in the West where institutional investors taking the biggest hits.
The Chinese financial sector is under-developed — Chinese citizens have few investment options, apart from the stock market and the housing market. This is actually how the Government planned things since the 1990s, when it sought to nurture a domestic consumer base that would drive the national economy. The idea was to create more disposable income (without hiking labour cost) by encouraging investments in two platforms: Real estate and stock markets. Both brought investors big rewards (which fuelled consumption) and funded key sectors like housing and infrastructure (which have disproportionate representation in the Chinese stock market). This explains why Beijing is desperate to protect the stock market now. But in the long term, it raises critical questions about China’s macro-economic resilience.