Why did China’s stock market crash ?
Stock markets are an indicator and must be in line with all the other indicators of the economy but this was not the case with China. Rate of growth in China had slowed down to below 7%, slowest in 25 years, whereas stock markets increased by 150%. Individual investors own 80 per cent of Chinese mainland stocks. Clearly something was wrong and the rise in the market was not justified. It created a stock bubble.
The 32% fall in the Shanghai Composite Index(SCI) in the past month wiped out value equivalent to 12 times Greece’s GDP. This was popping of the stock bubble. As the price curve accelerates, it seems that investing is easy and anyone can do it. Individual investors were a majority of the investors and many of them were first time investors because China’s stock investment experience is relatively new.
The stock markets are governed by the law of demand and supply. More demand, higher prices; more supply, lower prices. The total value of China’s stock market is still less than half that of the U.S. market, but the trading volume on many recent days has exceeded that of the rest of the world’s markets combined. This inflated prices over the year.
For last one year, the investments into the stock market (demand) rose to very high levels. as the Chinese property market went down. It has become famous for its abundance of empty infrastructures-stadiums, skyscrapers, and even cities i.e. is a lot of overcapacity and bad debt .Therefore, people looked for altiers to get returns This is partly why the Chinese government encouraged the stock market investments. It also knew that there were heavily indebted companies which need to raise money to clean up their balance sheets.
China’s economic policies are driven directly by its leaders, Xi Jinping and Li Keqiang; they assume that stronger domestic consumption will compensate for low exports. Government realized that there are these huge savings(people looking for returns) in China that can be put into the stock market. So it began talking up the stock market and encouraged use of margin debt – using borrowed money to invest in stocks. This almost always fuels investment bubbles and is main reason that, when stocks crash the ripple affect is enormous.
Realising this crazy debt-fuelled buying of stocks, the Chinese government finally sought to put curbs on margin trading. As soon as this crackdown on margin trading began the buying of shares slowed down. People started losing money, so they started selling their stock anticipating further price falls. This selling cycle reduced value from the market which eventually led to this collapse.
The second reason for this was that a large number of buyers in the share market had been using shadow banking system to buy their shares through what are called as ‘umbrella trusts’. Umbrella trusts allow investors in the stock markets to get lent money on a much higher rate of leverage ie the collateral requirement is much lower. Putting curbs on WMPs and shadow banking can wipe away 60% of the credit availability in the market and this happned in this case as well.
What are its implications on India ?
1) Metal Prices:
China is one of the largest consumer of metals in the world. A slowdown in China or even a possibility of slowdown means metal prices free-fall For example, Copper is trading at a 6-year-low and accounts for 40% of global consumption. Further, China is aggressively selling off its inventory of metals to raise cash . Indian metal-producing companies such as Vedanta and Hindalco stock prices have dipped which led to the SENSEX dropping 484 points on a day.
But India has a reason to cheer. As it is a developing economy with large consumption of metals for infrastructure and SMART CITIES, the low global prices mean lower costs.
2) Automobile Producers
China was a leading destination of Indian exports of automobiles. With declining consumption, its demand will fall. Tata Motors shares declined 6.2% this Wednesday.
Demand from China is expected to reduce, thereby oil prices might fall further. This is great news for India which relies almost completely on imports for oil. Therefore, low oil prices mean lower inflation, lower trade deficit, and higher production and economic growth.
4) Indian exports
To revive its economy China might devalue its currency to makes its exports more attractive (cheaper). This can affect exports from India as indian exports might become less attractive to importers especially goods like mobile phones. But this also means that Indian imports of Chinese goods will also cost less, but the former beats the latter.