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Key insights into China’s recent stock market crash

August 24, 2015 by Blog Editor


Almost ten weeks into a troubled summer and the Shanghai stock market has taken another massive lurch downwards. It has lost nearly 40% of its value from its peak on June 12.

But this time the sell-off is not an isolated incident: the today’s slump in Shanghai comes as the rest of the world increasingly worries about the state of China’s economy and its future growth prospects. The trigger of the sell-off was the release of a key index on Friday showing Chinese factory output at its weakest level for 77 months.

Investors have started fretting over the real state of China’s economy which helped to create a panic washing up on Europe’s and Asia’s shores Monday morning, led by the Shanghai Composite tanking by more than 8%. 

Shanghai Stock Market

It is still hard to fully capture the whole impact of today’s “Black Monday” but we aim to highlight some of the key insights into China’s recent stock market crash below.

Why are stocks in China falling?

Grandmas and cab drivers were all making small fortunes in a frenzy of “chao gu” or stir-frying stocks (Chinese slang for trading). The stock rally came at a time when the wider economy was slowing, puzzling many financial analysts but gravity seems taking effect.

“China’s stock market had become detached from the reality of China’s own economy, and appallingly overvalued,” Patrick Chovanec, managing director at Silvercrest Asset Management, said last month. Some argue that we see the long awaited correction.

How will the crash affect the rest of the world?

Only a few foreign investors have much direct exposure to these stock markets. Only 1.5% of Chinese shares are owned by foreigners, according to Capital Economics, because China still limits the amount of overseas investment.

The real concern for those outside China is a global economic slowdown and wider impact from a fluctuating stock market.

How does the Chinese government respond?

The People’s Bank of China has cut interest rates to a record low, brokerages have committed to buy billions worth of stocks and regulators have announced a suspension of new share listings.

The stock rout could undermine consumption because people nursing losses are unlikely to go to the mall and spend. From this can follow all kinds of risks for the economy and for the financial system.

Moreover, investors seem not to be convinced by government efforts. China’s stock market has been on a roller-coaster ride in recent weeks, sometimes opening with a jump of as much as 7%, before ending the day down by that much – turning the stock market into a casino.

It will remain interesting to see what measure the government will take over the next months to come. The “China experiment” seems to continue.

What does this mean for China’s leaders?

China’s “Black Monday” could prove a big challenge to China’s top leadership.

Beijing risks losing its credibility and if people see that they shoot that bazooka and the market continues to fall and then they realize that the government doesn’t control economic outcomes as much as they thought.

The measures Beijing has enacted may have undermined faith in China’s commitment to market reforms and may have led to more confusion about China’s growth prospects and stability of the whole system.

It is questionable if the government can reverse market movements with non-market-based policies. All it seems to create are setbacks for the Chinese capital markets with investors’ confidence in the Chinese growth model shrinking and real reforms not taking place. Voices from the mainland argue that necessary reforms in areas such as social welfare systems have been put on hold for too long.

By J Bren

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