The Shanghai Composite Index tumbled 8.3% on Tuesday, close to February’s fall of 9.9% which caused global turmoil and dampaned risk appetite for emerging market assets. But analysts maintain the stock market will continue to grow because of the country's huge liquidity and the asset bubble is unlikely to disturb world markets. Speaking at the Institute of International Finance spring meeting, Gerard Lyons, Chief Economist at Standard Chartered said: “because of exchange rate policy we have had too much liquidity particularly in the stock market asset; price inflation and volatility is rife”.
Chinese shares slumped after the government announced it would raise its stamp duty tax from 0.1% to 0.3% stimulating fears that the government will take imminent action to cool stock market investment. But stocks rebounded by 2.6% by the end of Tuesday amidst speculation the government will introduce a stabilization fund and not introduce a capital gains tax.
Lyons explained that the stock market has not only gathered significant momentum since Q306 but has deepened: “over a year ago people only used to buy 150 stocks and did not look past that top tier, now they are looking at the whole 1300 stocks.”
The government has introduced measures to dampen demand such as raising taxes on share trading. But Lyons argued that no radical policies would be introduced as there is a political impetus to maintain the status quo and counter measures could cause widespread anger and unrest. “Chinese equities has all the aspects of a bubble or a boom, but in the medium term expect more of the same...given there are political changes next year, all parties want to make sure that no situation deteriorates from their perspective.” But he argued that structural weaknesses of the economy meant that asset bubbles in China would remain until the domestic capital market was fully developed. “What China needs is a much deeper domestic financial system which will allow Chinese consumers the ability to buy more than stocks, houses or put their money in bank deposits, that however is going to take some time.”
Unlike February, investor appetite has not been affected; carry trades and demand for emerging market debt has remained strong. James McCormack, head of Asia sovereigns at Fitch, told Emerging Markets that there is broad consensus amongst analysts that the equity bubble will not precipitate a significant global downturn. “In February, maybe people were caught off guard and the surprise caused investors to flee. But not now.” Yusuke Horiguchi, Chief Economist at Institute of International Finance (IIF) agreed: “the stock market bubble is localised as it is only 4% of GDP, the stocks have been subject to a spectacular rise. But the equity markets in China can be classed as a narrowly confined market and not really connected to the global market system”.
For more analysis on the impact of China on global emerging market assets, see "Investors see China, not US, as key market risk".)