Chinese equities have been in freefall lately. Despite a rebound in recent days after numerous well-intentioned (if somewhat counterproductive) government attempts to break the fall, the Shanghai Composite is down roughly 25 percent from its peak.
It’s no wonder, then, that many investors are asking: Does the selloff represent a systemic risk to the global economy? My take: Though China is the world’s second largest economy, the volatility in China’s stock market is unlikely to have a material impact on either the global or Chinese economy. Here are six reasons why.
The roller coaster ride in China is mainly a domestic one. Foreign investment accounts for around 1 percent of Shanghai-listed A-Shares, a market driven by Chinese retail investor sentiment, not fundamentals. Thus, when the A-Shares market moves, it moves sharply and quickly. On the other hand, Hong Kong-listed H-Shares, which more foreigners hold, aren’t as skewed to retail and tend to be less volatile. So, while the H-Shares market didn’t capture as much upside from China’s bull market, it was more insulated on the way down.
The linkage between China’s economy and its stock market isn’t particularly strong. Unlike in the U.S., Chinese companies tend to access capital through bank lending rather than through equity markets, though the Chinese government is trying to encourage greater equity market capitalization via reforms. Indeed, the size of the Chinese stock market relative to China’s gross domestic product (GDP) is fairly small.
Stock weakness doesn’t necessarily lead to economic weakness, and this is true across economies. In fact, stock market weakness generally has less impact on the real economy than real estate weakness. In the U.S., where market cap relative to GDP is much larger than in China, the bursting of the tech bubble in 2000 only resulted in a particularly mild recession.
While Chinese growth is slowing, the pace is measured. While China’s economic growth slowed in the first quarter, it managed to stabilize at 7 percent in the second quarter. Though most of the damage to the market didn’t occur in the second quarter, thus far, the recent stock market volatility doesn’t seem to be having a noteworthy impact on China’s economic fundamentals.
Chinese officials remain in easing mode. Markets seemed to interpret Chinese government intervention to stem the selloff as coming too early and as a sign of panic from the Chinese authorities. However, some of the government measures—such as encouraging share buybacks—have helped stabilize markets. Looking forward, the People’s Bank of China (PBOC) has plenty of spare power to support the Chinese economy and financial markets, unlike some developed market central banks, and it will likely continue to implement strong countermeasures. Indeed, any sign of slowing growth in China should be met with further easing policies, so we’re going to see lots of stimulus in various forms to help mitigate the damage from the recent rout.