Fallout of slowdown in Chinese economy

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Fallout of slowdown in Chinese economyEconomic reforms introducing market principles began in 1978 in China that led to unprecedented growth of 9.5% per year. Per capita income grew 6.6% yearly. China was largely seen as engine of world and regional growth.

But recent crash of stock market in china that started in July 2015 has sent jitters across the world about stability and strength of Chinese economy. Increased middle class in China and its participation in stock market though helped country’s stock exchange reach record heights. But it is also linked to the crazy fall that began in July 2015.

CAUSES OF CHINESE MARKET CRASH

• Root cause is that over the past year investors poured more and more in Chinese stock market even though companies’ growth profile was weak.
• A big portion of participants are enthusiastic retail investors whose participation led to development of a classic bubble. On June 12 the bubble popped and Shanghai index lost about third of its value before rebounding.  Again on 24th July, Shanghai Composite Index was down 8.5% which was the worst one day drop since February 2007. Next day again the market was down 7.6%. People’s daily has declared these days as black Monday and Tuesday.
• Proximate cause for the chain of events is the devaluation of Yuan by about 2% on 11th August. More than 5 trillion US dollars has been wiped off on global stock prices since then.
• Further disappointing data on slowing manufacturing activity and services sector adds a cause to the meltdown. Chinese PMI fell to 49.7 in August from 50 a month ago. This is the lowest in three years.

CONSEQUESCES ON WORLD AND INDIAN ECONOMY

• Nervousness led by Chinese market crash has radiated outside China. Nikkie index has slipped by 4.6%. European bourses are down 4-5%. DOW opened down more than 1000 points.
• Pain extends beyond the stock market. Emerging market currencies are tumbling. Commodities are sinking. Oil has hit six and half year low. Gold is down. But low prices of commodities like copper; aluminium is good news for India. As a consumer, cost of constructing new infrastructure especially smart cities will come down.
• It may be bad for Indian automobile producers like Tata Motors as China is its fastest growing market.
• Weakening outlook for Chinese growth and slip in Chinese currency have put pressure on emerging economies and especially those whose growth model depends on Chinese demand for industrial and other commodities. Increase in Chinese demand account for 50, 44, 66% of export growth of Hong Kong, Japan and Taiwan.
• Countries like Canada, Brazil, and Australia bolstered their economy by selling to China. Also growing middle class became attractive market for American companies.
• While Indian and other markets have witnessed a knee jerk reaction of a crash. There may not be a direct long term impact on India.

Despite the above consequences there is not a major reason for panic. Shanghai index is still up 43% on its level a year ago. Also Chinese market is an isolated market where most investors are domestic. Foreign investors can invest in Chinese shares only in Hong Kong stock market which is more mature and stable. This has the effect of containing the economic disaster within China.

Further Asian governments are in far better position to weather these changes in economic climate.

Moreover steps taken by the government in China may give a valid reason for optimism. Government has announced new stimulus measures to boost economy. Also it gave money to brokerages to buy stocks and ordered companies not to sell their shares. It has also suspended listing of new companies.

People’s bank of China has cut its lending and deposit rates by 0.25%. It is fifth time in nine months.

Given the modest nature and limited effectiveness of stimulus measures that China is likely to implement, the rest of the world’s cause for nervousness about China seems unlikely to disappear for long.