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China's meltdown

Beijing's response underlines need for deeper reforms

Business Standard Editorial Comment  |  New Delhi 

The meltdown across China's markets has already caused more financial damage than Greece, and it could represent a bigger threat to the global economy. Over the past year, a massive bubble brewed up in Chinese assets, even as growth slowed. That bubble is now bursting. Given China's sheer size and large contribution to trade, the consequences may be very serious. Equity and commodity markets around the world have dropped in tandem with the Chinese crash. China's economic policies are driven directly by its leaders, Xi Jinping and Li Keqiang; they are based on the hope that stronger domestic consumption will compensate for tepid exports. But individual investors own 80 per cent of Chinese mainland stocks, and, given the decline in the value of their portfolios, consumption could slow. The crash has occurred despite desperate efforts to reverse the trend. It calls into question carefully crafted plans to link markets in Hong Kong and Shanghai seamlessly. It may further delay the inclusion of Chinese companies in the MSCI indices.

The fall in the Shanghai Composite Index by 32 per cent in the past month has wiped out value equivalent to 12 times Greece's GDP. The CSI300 is down by 31 per cent in the same time. The ChiNext Index, which tracks smaller listings, is down 36 per cent. The Hang Seng, Hong Kong's premier index, is down 14 per cent. Extreme measures have already been taken - so much so that it is hard to see what else the authorities might try. The Chinese Securities Regulatory Commission or CSRC has eased margins and reduced transaction fees. As many as 28 large IPOs have been shelved, effectively freezing the primary market, to discourage money being pulled out of the secondary market. Stern warnings have been issued against "irresponsible rumours" and short-selling discouraged by threats of investigation of "manipulation". Brokers have been told to accept a wider range of assets as collateral, including real estate. Pension funds have been allowed to invest in equity. China's sovereign wealth fund, the China Investment Corporation, has committed to buying shares through a subsidiary. The People's Bank of China (PBoC) has cut interest rates and set up a financing line for the CSRC, in effect committing to lend money to speculators. A consortium of 21 large Chinese brokerages has issued a statement committing $19.4 billion to exchange-traded funds dealing in Shanghai blue chips.

Read more from our special coverage on "CHINA MARKET MELTDOWN"

Regardless, the sell-off has continued. If all the collective action from the CSRC, the PBoC, brokerages does not stabilise prices soon, deeper questions would be asked about the government's response, which has so far been perplexing. Even though the stock market it is down about a third over the past four weeks, it is still 80 per cent higher than the level that prevailed at the same time last year. The Chinese economy, although slowing, has stabilised somewhat and other asset markets have not seen a similar kind of turmoil. Moreover, the Chinese stock market's role in mainland China is still relatively small, with the free-float value of its markets estimated at about a third of its gross domestic product, compared to almost 100 per cent in developed countries. Also, the stock market in China still absorbs less than 15 per cent of household financial assets. In such a situation, the Chinese government's intervention is likely to be seen as a panic reaction. Not surprisingly, the markets dipped further even after the array of interventions, perhaps fearing that the government may have responded in that manner after anticipating a bigger financial problem ahead. One reason for the Chinese government reaction to the stock market could be that it has routinely taken credit for the stock market's bullish performance, often claiming that this was attributable to the economic reforms the government had planned to unleash. The markets' fall was thus as much a blow to such claims as an indication of the government's limited ability to influence markets. For the Chinese government, this would be an important lesson and this should hopefully persuade it to take up the more formidable challenge of liberalising its economy.

First Published: Wed, July 08 2015. 21:40 IST