China stock market plunge likely to have limited impact on real economy
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OVER A MONTH OR SO, China's stock market has turned from the world's best performer into the worst.
After an impressive 150-per-cent rally in a one-year run-up to its peak |in mid-June, the Shanghai-Shenzhen CSI300 stock index has fallen by |more than 30 per cent in the past month.
The plunge wiped out more than US$3 trillion from the world’s second-largest stock market. That might look alarmingly large, but the actual impact on wealth and the real economy will likely be limited.
The self-propelling sell-off was mainly due to a liquidity crunch in |the small-cap space, not a deterioration in economic fundamentals. |The government’s measures have |successfully arrested the free-fall, |as the central bank pledged to provide a direct liquidity injection into the China Securities Finance Corporation (CSF).
The CSF will in effect act as a market-stabilisation fund and play a key role in stabilising investor expectations. The market has rebounded by more than 10 per cent since the measure was announced.
The impact from the stock-market rout will manifest itself in the real economy though two main mechanisms. One is the wealth effect. People whose stocks declined rapidly will feel poorer and spend less. This will dampen domestic consumption.
However, the negative wealth effect from the equity slump will be felt by a limited number of investors. According to China Securities Depository and Clearing Corporation, stock-trading accounts totalled 175 million at the end of May, of which 50 million were active.
Compared with China’s population of 1.3 billion, those actively trading were merely 4 per cent.
According to the China Household Finance Survey, equity investment makes up less than 10 per cent of household wealth, while more than 40 per cent is in housing. The fact that house prices in China started to recover in recent months should help offset the negative effects from the stock market.
The other mechanism is the rising cost of funds and the difficulty of |raising capital in the equity market. The impact through this channel should also be limited, as equity is not the main channel for financing in China.
Equity accounted for only 4 per cent of total financing in the past 12 months, while bank lending provided more than 70 per cent.
The risks associated with margin lending have also eased as a result of the sell-off. Outstanding broker margin financing shrunk for the 13th day to 1.46 trillion yuan on July 8, 36 per cent off the peak of 2.3 trillion yuan seen on June 18.
The sell-off, in my view, has opened up investment opportunities in China, as it brought H-share valuations into value territory. Their price-to-book ratio declined to 1.1 times, the level seen during the trough of the global financial crisis in 2009.
Komsorn Prakobphol, head of strategy at Tisco Strategy Unit, can be reached at www.tiscowealth.com or [email protected].
