Why Chinese Market Crash is a bigger peril than GREXIT?

The possibility of Greece's exit from eurozone (Grexit) has dominated headlines across the world, with many analysts saying that the potential event could unleash a contagion that will create turmoil in global financial markets. But most financial markets, including India's, held on despite the "no" vote in Greece, announced on Monday. There's increasing realization that the volatility in Chinese markets is a bigger concern because of huge size of China's economy. China's stock markets have shed nearly $3 trillion in market value in the last three weeks, which is more than 10 times Greece's gross domestic product of $237 billion in 2014.
Here's your 10-point cheat-sheet to the story:

1) Chinese stock markets fell as much as 8 per cent on Wednesday, days after the government unleashed additional measures to arrest the slide in equities that threatens to destabilize the world's second-biggest economy. China's main index - the Shanghai Composite - has crashed around 34 per cent from 5,166 to 3,421 in just three weeks since June 16. Chinese markets, which had topped $10 trillion in market capitalization for the first time last month, have now shed nearly 1.5 times India's GDP ($2 trillion) in the last three weeks.
2) The crash in Chinese markets comes on the back of a bull run that saw the benchmark index soar 150 per cent from July 2014 to mid-June 2015. In 12 months, Chinese stock markets rose enough to create $6.5 trillion of value, according to Bloomberg data. David Woo of Bank of America had termed the rally in China's markets as the world's largest stock market bubble since the dot-com boom of the 1990s.
3) The rally in Chinese markets had no economic fundamentals as it came in a period that saw China growing at the slowest pace in 24 years and corporate earnings lagging estimates. The relentless rally drove valuations to unsustainable levels. According to New York Times, the price-earnings ratio of the Shanghai composite index soared to nearly 26 by June 2015 as compared to 10 a year ago.
4) The rally in Chinese markets was triggered by easy money as the country's central bank cut interest rates thrice since November 2014 to kick-start the economy. Easing of rules related to margin trading (investing in stocks on borrowed money) led to a debt-fueled rally in stock markets.
5) The uniqueness of players in Chinese markets further complicated matters. 85 per cent of trading in China is done by retail investors, and to take advantage of the spectacular rally, many investors (including university students, barbers and janitors) took to margin trading. Most of these retail investors bought small cap stocks and invested in new IPOs (initial public offering). As markets started falling, margin calls were triggered (happens when shares bought with borrowed money fall below a certain level), forcing many retail investors to liquidate shares to raise cash, and further depressing markets.
6) The market mayhem has forced many Chinese companies to ask for their shares to be suspended from trading. 1,300 of the 2,800 companies listed in Shanghai and Shenzhen had filed for a trading halt by Wednesday. This has further dented sentiments.

7) The Chinese government has reacted to the free fall in stock markets by further cutting interest rates and relaxing margin trading. On Saturday, it suspended the issuance of new share issues and asked brokerages to buy at least 120 billion yuan ($19 billion) of stocks (helped by China's state-backed margin finance company) in a bid to halt the selloff in stock markets.
8) According to The Economist, the crash in Chinese markets could be damaging for the country's development. "For investors from households to pension funds, a well-functioning stock market is essential given very low interest rates and the shortage of other ways to earn a decent return. For companies, equity financing is needed as a viable alternative to bank borrowing to reduce their reliance on debt," the magazine said.
9) The slump in Chinese markets has also impacted the commodities markets, with prices of copper, coal, natural gas and iron ore falling to 2015 lows. This is bad news for economies that are dependent on export of commodities.
10) Despite the selloff, many analysts continue to be optimistic about Chinese markets. Nomura termed the recent fall in Chinese markets as "much needed consolidation". It expects a rebound in Chinese markets after the sharp selloff. "We iterate that between now and the interim result season in August is where Chinese equities may bottom and subsequently rise higher," Wendy Liu, analyst with Nomura, wrote in a report on Tuesday.

(With inputs from agencies)


1. NDTV 

No comments:

Post a Comment