InvestmentsAug 4 2015

China teetering on brink of a crisis

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China teetering on brink of a crisis

Volatility in Chinese stockmarkets has raised economists’ concerns of an impending financial crisis in the country.

Last week the Shanghai Stock Exchange recorded the second-biggest fall in its history as the Shanghai SE Composite index plunged 8.5 per cent, the sharpest decline since 2007.

This follows the Chinese authorities taking unprecedented steps in the past month to stop the equity rout.

These measures, along with the stockmarket’s response to the actions, has led economists to raise warnings that China could be on thin ice.

“The methods the government is taking could prompt a financial crash further down the line,” Schroders’ emerging markets economist Craig Botham said.

“It’s beginning to resemble what happened in the sub-prime market in the US.”

The government’s policy response has included a ban on short selling, barring sales by big shareholders and extending loans to brokerages from China’s central bank.

Initial public offerings have also been frozen, while state investment funds have been dumping money into shares and tracker funds to boost index levels.

Anastasia Amoroso, global market strategist at JPMorgan Asset Management, noted that the government’s support could only sustain stabilisation “temporarily”.

She explained the government had achieved stability by restricting selling and mandating buying, but had funded that buying only up to certain levels.

“Once those levels are reached or get close to being reached, and the selling is not exhausted, downward pressure may resume again,” Ms Amoroso said.

The strategist added that “the true path to stabilisation” was for the market to reconnect with its fundamentals.

Ms Amoroso added there was a risk of economic contagion through the banking channel, “where banks may have to suffer losses on their margin financing and wealth management products”.

“This in turn could hamper credit growth in other areas that actually support the economy,” she added.

However, some experts have questioned whether the government will stem its accelerated pace of policy change.

Jan Dehn, head of research at emerging markets specialist Ashmore, doubted whether Beijing’s approach would be to “reverse reforms”.

“The volatility is all the more reason to push ahead with the reforms, which aim to introduce more institutional investors,” he said.

The Chinese equity market is dominated by domestic retail investors, but this could be good news as it means the risk of contagion is low, according to some experts.

Mr Botham noted the volatility in China “won’t be invisible, but it will be minimal”.

However, investors should not be too complacent, since China is the world’s second-largest economy.

Anna Stupnytska, global economist at Fidelity Worldwide Investment, added: “China is a big headwind for the global economy.

“The direct impact is for emerging markets and other countries that trade with China, such as Korea.”