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China’s Stock Market Reflects Serious Economic Troubles

Nov 05, 2018
  • Sara Hsu

    Visiting Scholar at Fudan University

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China’s stock market is in bear territory, as market sentiments are low. The Asian nation is attempting to absorb the brunt of a deleveraging campaign as well as a trade war with the U.S. The market plunged and rebounded last month before dropping again, sparking a global downturn. Although Chinese officials followed this drop with the announcement of new measures to slow the downward spiral, confidence was only temporarily restored. As the stock slump persists, investors are becoming increasingly wary of negative economic signals, such as the lower than expected growth figures in the last quarter.


Economy on a Downward Trajectory

China's economy is suffering from reduced production as a result of constrained lending and the trade war. Some smaller firms have suspended production for the year and others have defaulted on debt repayments. The nation reported a third quarter growth rate of 6.5%, which was below economists' expectations of 6.6%. Since China’s government is a strong participant in the economy, both directly and indirectly through policy requirements, the inability to meet an expected growth rate demonstrates a serious shortfall. This is China's slowest growth rate in ten years, which results from structural change toward a consumption-based economy and a reform program placed on pause as the country attempts to reduce high debt levels among its state-owned enterprises and wipe out overcapacity in heavy industry. These efforts have let critical components of GDP, investment and consumption, lag behind.

To make matters worse, the U.S.-China trade war is ramping up, with tariff rates expected to rise from 10-25% at the end of the year and the number of goods subjected to tariffs likely to increase as well. Uncertainty is high, and the massive slowdown in production has reached most sectors. For example, the manufacturing purchasing index fell by 0.6 points in October. The trade war hasn't even fully hit yet and will result in ongoing trauma to growth figures as the impact of tariffs intensifies.

Pain in the Stock Market

China's stock market is reflecting these issues. The Shanghai Composite has lost 27% of its value since its peak on January 24 and the Shenzhen index is down by 34% since January. This has had a negative impact on global shares, as overseas investors worry that shocks from China’s lagging economy will hit the rest of the world. The Dow Jones Industrial Average, Nasdaq and S&P 500 Index have reflected this turmoil.

Officials have attempted to improve conditions in the stock market. The China Securities Regulatory Commission recently stated that it will ease rules on reverse mergers to shorten the time required for companies to obtain back door listings (listing by merging with a listed company) to reduce regulatory pressure in the stock market. The next day, the Shanghai Stock Exchange announced that it would create funds to bail out companies that pledge their stock shares as collateral for loans. The Shenzhen Stock Exchange joined the chorus, saying it would work with local governments and financial institutions to assist firms. China's central bank has also stated that it will provide ¥10 billion ($1.4 billion) to China Bond Insurance Co. to extend credit for debt sales by private firms. Further, President Xi Jinping has promised "unwavering" support for non-state firms.

However, there is fear that too many of the listed company shares have been pledged as collateral for loans. The total amount is equal to 10-12% of the A-share market cap, according to Sean Darby, chief global equity strategist at Jefferies. This is starting to create a downward spiral as margin calls (demands for additional securities to cover losses) and forced liquidations are carried out and threaten to bring contagion to the real economy, which is already under pressure from dampened demand.

At the moment, it appears that risk is under control, but just barely. If the stock market continues to melt down, government intervention may be required to stem sharp price declines and reduce the impact on the rest of the economy due to the knock-on effects of margin calls. All of this only serves to compound the lack of funding and bearish sentiment that are worsening the slowdown.

Government intervention is necessary but certainly not desirable, as it moves China’s economy even further away from the market-oriented system it has been striving for. At this point, the prospects of reform appear dim, as the nation attempts to curb assaults on its very economic viability. A lot must happen in order to improve the country’s prospects: calling off the trade war, removing bad debt, and stimulating consumption and investment will all have to occur before China gets back on its feet and the stock market appears healthy once again.

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