In spite of the unnerving stock market crash in July last year, Chinese economic fundamentals look strong and the country is poised to grow steadily, according to Mr. K Subramanian, former Joint Secretary in the Ministry of Finance, Government of India.
Initiating an interaction on “Chinese Stock Market Conundrum and Implications for the World” at the Chennai chapter of Observer Research Foundation on February 13, he said the Chinese economy is moving from an export oriented model to a more inward looking economy that relies on domestic consumption. China has been using its monetary policy, state owned banks and other financial institutions to spur aggregate domestic demand, continuing in this trend, a greater emphasis has been placed on the stock market to mobilize savings and redistribute capital in the economy.
Mr. Subramanian pointed out that the Chinese economy has a very high savings rate, and much of the savings were earlier pooled into real estate (which caused the asset bubble in property prices) and luxury items. Unlike other stock markets, a large portion of investments in the Chinese market is driven by bank credit. At its peak valuation (stock market), the margin debt was valued at 3.5% of the GDP and nearly 9% of free float market-cap; this excludes hidden leverage from other type of borrowings such as consumer credit and other trust products, he said.
Talking about the stock market crash, Mr. Subramanian said the global press overreacted to the crash, causing panic in international financial markets. He said questions on the stability of Chinese economy that ensued soon after the crash were largely manufactured by the western media that are wary of China’s geopolitical rise.
At its peak valuation, the Chinese stock market was significantly overvalued with a forward PE of 61. Given the reduced global demand, drastic fall in commodity prices, and Xi Jinping’s new reform agenda, a correction in the market was long expected, he said.
The stock market had crashed violently on July 7 2015 and the valuations dropped by one third. Quick intervention by Chinese authorities stabilized the market halting the rapid slide in asset prices. Circuit breakers were put in place to restrict trading in vulnerable stocks and manage market volatility. The global press was quick to spread this panic to other markets worldwide. However, the fall in the market does not reflect the true state of the real economy, noted Subramanian. The role of capital markets in mobilising and efficiently allocating capital has become questionable in today’s extreme financialisation of the economy. Preeminence of finance capital has detached capital markets from the real economy. Asset prices are largely driven by bullish sentiments, rather than being based on sound economic fundamentals.
Enumerating the causes for the plunge, Subramanian said that the foremost reason for overvaluation of asset prices was due to FII inflows which sought higher returns in emerging markets. This trend accentuated post the 2008 financial crises, when the growth rate started to stagnate in developed nations making emerging markets an attractive destination for higher returns. With the investment sentiment picking up in the western world (especially in the US) and strengthening of the dollar globally, foreign investors have started to withdraw money from emerging markets, seeking better avenues for investment. Further, the rebalancing policies of the government and market reforms were expected to accentuate the downtrend in the market which led the violent crash in July 2015.
Mr. Subramanian said that the plummet did not have any “wealth effect” on the Chinese economy. Unlike the developed nations, where a major portion of individual savings is pooled into the stock market, in China individual holdings in the market form a minuscular part, hence there was no major loss of wealth. Further, the market has bounced back marginally since the fall last year, additionally the share price of technology majors and state owned enterprises are still strong. Nevertheless, this crash has instigated a raging debate in China’s political corridors about the pace of modernization and market reforms.
China is all too eager to deepen its capital markets, especially after the Yuan was added to the SDR basket. Chinese authorities have intervened more than once to stabilize the market, which is contrary to the epithet of free markets. Transparency is another major concern in China’s financial markets, there is no clear communication on the strategies, policies and actions of major state owned banks. Also, there is no transparency in dissemination of its financial policy, technocrats are apprehensive to clarify policy directions that may land them in trouble with the polit bureau.
Commenting on the global implications of China’s market crash, Subramanian said that global indices showed much coherence with the Chinese stock market. Indices across the global fell by significant percentage points, rupee touched its intraday low, and it created exchange turbulence in international forex markets. However, the global effect on stock prices was minimal although over exaggerated by the media. Markets across the globe have recovered since last July and there is much exuberance in the US markets owing to its domestic growth prospects. Global finance has factored in the new normal and markets are expected to continue the bearish trend, due to reduced global demand and growth prospects, opined Subramanian.
Speaking on the market characteristics, Subramanian said that the “Dual System” feature unique to the Chinese stock market creates an asymmetry between foreign and domestic investors by constraining each type of market participant to invest in specific securities. Many companies that command high valuations are technology and internet based firms, along with several state owned enterprises. QFIs had played a major role in driving up asset prices during the initial years. However the recent spike in asset valuation is largely attributed to millions of affluent investors who started using the stock market as a casino. Extremely high real estate prices and stringent gambling regulations made the stock market appear as an attractive avenue for quick profits.
Responding to questions on outflow of FDI from China, Subramanian clarified that the decline in forex reserves is due to policy imperatives rather than outflow of funds from China. China has been diversifying its forex reserve, investing in overseas assets and acquisition of commodity companies to stabilize its import bill.
As a concluding remark, Subramanian said that the stock market crash has not affected China’s growth trajectory, albeit creating a minor problem for the government in the short term.
This report is prepared by Deepak Vijayaraghavan, Associate, ORF Chennai