Are you too caught up with latest happenings in Greece? Worried about its financial repercussions on Indian markets and economy? Its time you shift your focus! A bigger threat is playing out right next door, in China. After rising to historic highs, Chinese stock markets are witnessing an unabated free-fall since last month. This has raised fears of a stock market bubble. Some analysts have described the situation as the biggest stock market bubble since the dot-com boom of the 1990s.
We give you a lowdown of the situation in China and its possible effects on other countries, including India:
What is going on: Chinese markets were the best performing emerging market in the world last year. The country’s main index Shanghai Composite more than doubled and was up over 40% this year. This was until June 12. Since then, China stocks have plunged 30% in three weeks and to four-month lows. On June 8, in an unprecedented move, around 1300 companies—half of China’s listed companies, suspended their trades in the stock market. The move was taken to insulate themselves from the massive declines in the equity market.
Why markets crashed: Three main reasons are being cited for the dramatic fall:
Chinese stock prices were highly overvalued. The market continued to rise because of herd mentality—investors see others buying them and so they buy those stocks too—and not its inherent fundamentals. There were fears that stock prices have reached unsustainable levels at a time the economy is not doing too well
A country’s stock market performance is directly correlated to its economic performance. However, there has been a worrying disconnect between the two in the case of China. Chinese economy is losing steam .Its GDP growth rate halved from 14% in 2007 to 7.4% last year. Investment and retail sales have also declined. This indicates that the markets were driven purely due to momentum and not the country’s inherent fundamentals.
Another reason for the sharp fall is the rise in margin trading. There has been a 5-fold rise in margin debt. In margin trading, an investor borrows money from his broker to purchase stocks. If the stock price falls below a certain level, then he will have to sell off some shares to pare the fall.
Wealth eroded: The rout in Chinese shares has erased at least $3.2 trillion in value, or twice the size of India’s entire stock market, according to Bloomberg. The wealth alone is equal to 10 times the size of Greece economy!
China government intervenes: The Chinese government has intervened to stem the fall. The stock market regulator has suspended initial public offerings (IPOs) for the time being. The country’s central bank cut deposit and lending rates, its fourth rate cut since November. The steps were taken as a response to the weak economic data and to inject more liquidity in the markets. However the move has proven counter-productive till date. Investors seem to be losing faith on the Chinese government.
Effect on India: India could feel the heat of the turmoil in China. The Sensex slumped 1.7% on Wednesday. However, analysts view the fall as a temporary shock. They are of the opinion that the fall in China is good news for India. With, the turmoil in Chinese markets, India could be the next best favorable investment destination. A flight of capital from China to India is a possibility in the future.
However, if the turbulence in Chinese markets spills over to its economy, India could be in trouble. This is because China is India largest trading partner. Turmoil in the Chinese economy and markets would mean businesses could pull back from investments till the situation stabilizes.
Contra view: Some analysts are of the opinion that the market crash is temporary and there is no bubble as such. The valuations are not too high as projected. The Chinese economy has clocked in remarkable growth for years. While its markets slumped after the Lehman crisis of 2008, it is reaching its correct valuations now.
By SIS Pvt Ltd
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