The Shanghai Stock Exchange Composite index dropped another 7.63% on Tuesday. This is bad for Chinese equity investors, who had piled into the market expecting ever rising prices. But it’s not at all clear there should be lasting implications across wider markets.
First of all, the Chinese equity market is largely made up of domestic Chinese investors. Even emerging market fund managers are not being punished in the Chinese equity rout, while other portfolio managers are not directly exposed at all. They are not taking losses or being forced to liquidate positions elsewhere, except to the extent that other markets are tracking Chinese sentiment.
Secondly, the macro implications of the Chinese stock market crash/correction — whatever you want to call it — are limited. The huge inflation of the Chinese equity market did not appear to have any tangible benefit for China’s real economy. So it’s not clear that the return to sanity is going to hurt the real Chinese economy.
Michael Pettis, a professor at Peking University’s Guanghua School of Management has suggested several ways that the equity crash could hit the wider economy.
Firstly, it is possible it could shift wealth from poor Chinese to rich Chinese, causing consumption to drop. But, as Pettis points out, there no information on the magnitude of this potential shift. Secondly, households might cut back on consumption if they think the economic outlook is more uncertain. Pettis thinks the least likely, but potentially most damaging impact, would be if the crash undermines confidence in Beijing to manage the economy and thereby undermines the financial sector.
But it’s very early to assume that any of these effects will come to pass.
Even though the Chinese-A share market has lost 40% since its June peak, analysts point out the economy is still in much better shape than before the 1997 Asian crisis and is slowing down for the right reasons. FX reserves are 34% of GDP, the current account surplus is 2.8% of GDP and the government still has room to stimulate the economy through cutting interest rates and the reserve requirement ratio — actions which, on Tuesday, appeared to send US and European stocks bouncing off yesterday’s lows, boding well for the Asia open on Wednesday.
If China’s economy does suffer on the back of the stock price declines, other emerging markets should avoid damage. Of total emerging market exports (ex-China) less than 9% goes to China, and of that small figure a decent chunk are goods that are then re-exported to the rest of the world, according to Emerging Advisors Group analysts. Nor does China have much to do with falling oil and agricultural prices, which, they add, are two of the big drivers of stagnant EM export growth.
What the Chinese economy does matter for is ores, minerals and non-food raw materials. So if you have a large chunk of your economy devoted to exporting copper, bauxite or timber, and the equity market volatility leads to a deeper slowdown than was already expected, bad news for you. But this is a limited group of the broad emerging market universe.
Nor, for that matter, does China’s recent currency adjustment necessarily have much read across to other emerging markets. Nikko Asset Management analysts believe the currency is 5%-10% overvalued, and that the government is taking steps to remedy this in a controlled manner while moving towards a more liberalised exchange rate regime. Meanwhile, on a trade weighted basis, the renminbi is still appreciating and there are no signs of any increased fluctuations in the dollar/renminbi exchange rate, according to Emerging Market Advisor group analysts. The move has not made a whit of difference to China’s competitiveness with other emerging market exporters.
This is a key point, because what matters for emerging economies is demand from developed markets, and the price of commodities that emerging economies export. So worry about the drop in oil prices, which has been going on for months, and keep your fingers crossed for an industrial recovery in the US and Europe. But China shouldn’t wreck the emerging markets story.