July 2015
Schroders
Talking Point
China's crashing stock market could hurt
economic growth
Craig Botham, Emerging Markets Economist
China’s market has provided perhaps the most exciting ride for investors so far this year. The
composite index was at one point up almost 60%, easily outpacing the rest of emerging markets and
indeed the rest of the world, but its fortunes have since turned.
The timing of the rally - with take-off in March - suggested a disconnect from economic fundamentals. Activity
data started the year poorly and then disappointed spectacularly in March; hardly the environment for earnings
to perform well. But along with weak data came expectations - and promises - of policy support. Liquidity
injections by the central bank in particular helped build sentiment, and a mindset that said that every
disappointing data point from now was a signal to buy more. While undoubtedly a bubble, in the sense that the
elevation of price-to-earnings (PE) ratios is difficult to justify in an economy suffering excess capacity and weak
demand, investors were arguably not behaving entirely irrationally.
Policymaker actions
The rally had a great deal of policymaker support. The authorities are seeking to rebalance the financing mix of
corporates, away from a high reliance on debt. For this to succeed, firms will need equity finance, and a
buoyant stock market provides the best conditions for a series of IPOs. Banks are also looking to raise equity
finance as they seek to recapitalise, which will help provide demand, in turn, for local government bonds –
another aspect of the country’s rebalancing. All the same, we have seen large one-day falls in the market when
the regulator has moved to reduce volatility, which pointed to the fragility of the bubble. For investors in
Chinese equities, one such action by the regulator - restricting margin financing, which has set global historic
records by reaching 3.4% of GDP - prompted an ongoing sell-off.
Macro consequences
Undoubtedly there will be some concentrated financial pain among highly leveraged investors, but the
macroeconomic consequences are less clear cut. While in the US this kind of market rally would have been
associated with strong positive wealth effects, this has been less apparent in China; retail sales continued to
soften even as equities touched new heights. , A downturn could further inhibit consumer sentiment and
spending.
Turning to a breakdown of first quarter GDP, however, what is notable is the surge in the financial sector
contribution to GDP growth, at 1.3% compared to its previous 0.7%. This reflects a boom in brokerage
business which is unlikely to be sustained in light of current market conditions. This will likely weigh on growth
in the third quarter, particularly if efforts to shore up the markets are unsuccessful.
SchrodersTalking Point
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Hard landing?
A final question is whether a stock market crash could trigger a hard landing. There is an argument to be made
that it would undermine faith in the assumed omnipotence of the government in handling the economy, with a
potential focus being the rest of the financial system. On balance though, our view would be that the real
economy is still sufficiently disconnected from the equity market that the impact on growth should be limited to
the effects felt from the financial firms involved and those wealthier households able to participate in the rally,
and subsequent bust. Most firms are not reliant on the equity market for financing, and the People’s bank of
China (PBoC) is capable of providing ample liquidity to keep credit markets going. It will, however, hinder
efforts to tackle debt sustainability for local governments and state owned enterprises (SOEs), and also the
recapitalisation of banks.
In all, a slumping stock market presents a real risk to the attempts to rebalance and refinance the economy,
and a genuine hurdle to hitting the 7% growth target for this year.
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