Chinese Dragon in Firefighting Mode

Chinese Dragon in Firefighting Mode

The massive Chinese stock market rally of 2015 has finally come to an expected end. After peaking in second week of June, the Shanghai Composite Index and Shenzhen Composite index have fallen by around 30% and 40% respectively. Nearly half of the companies listed in the two stock exchanges have halted trading in their shares to prevent a further fall. The contagion has spread even though the Chinese government has cut interest rates, suspended IPOs, relaxed margin financing standards and have instructed state owned insurers and funds to support the indexes through massive buying operations.

Though the measures of the Chinese authorities temporarily seem to have put a floor on the prices, experts opine that such short term measures can only delay the inevitable. The Chinese News media has also rumoured about the hand of “foreign financial institutions” in instigating the stock market riot. But the fact is that foreign investors own around 1% of the stocks in the mainland and moreover the foreign investors allowed to trade by the Chinese authorities are not even allowed to sell short. The Economist has reported that retail investors have been behind the original “super bull” run. Individuals account for around 80% of trading in China, massively outweighing institutional investors.

The Effect on the World

The stock market boom had been led by the mom and pop investors, borrowing up to 970 billion dollars in margin funding according to a Bank of America strategist. Thus, around 10% of China’s GDP is at a potential risk. Further turmoil can distort credit flows due to the impairment to financial institutions' balance sheets engaged in margin lending.

Chinese consumers are now the world’s growth engine in luxury consumption. The stock market gains are expected to have fuelled massive spending on luxury goods, tourism, real estate and foreign education. Chinese tourists spent an estimated 165 Billion dollars on overseas travel last year. The spending was more than any other country and up by 28% from last year. Chinese buy 12% of the world’s luxury goods and account for 40% of French luxury sector sales.

If the selloff continues, it could be really bad news for American companies’ dependant on Chinese markets for increasing sales. General Motors China reported flat auto sales in the month of June, even after slashing prices by 20% on many models. Apple’s continued success is now based very much on selling more IPhones in China.

The rise and fall of the Chinese markets have been a spectacle for majority of the foreign investors due to the restrictions in place on investing in the Chinese market by their government. But it is unsure how the American markets will play out if the panic were to trigger an economic slump in China. The world and especially many American companies are now dependant on Chinese consumption to grow and the turmoil can be a drag on their profits in a new inter-connected world.