Monday mayhem

On an eventful Monday, panic struck the global economy after Chinese shares saw a dramatic 8.5 percent fall after trading. The Chinese market is now down 38 percent from its June peak. Over the past month, Beijing has taken extreme measures to reverse the stock market’s decline. These measures, however, now appear to be failing. The sharp decline in China’s benchmark Shanghai Composite Index was soon followed by a broader Asian sell-off, with stocks in Japan, Taiwan, Hong Kong, South Korea, India and Australia all posting major losses. 

The question that must be posited is this: why do events in the Chinese stock market result in massive repercussions for global markets? Ever since the financial collapse of 2008 and the following downturn in large parts of the global economy, particularly the European economy, China had emerged as a bastion of consistent growth, both in terms of real economic and <g data-gr-id="46">notional</g> market parameters. With a succession of poor indicators on key economic parameters as well as the drastic collapse of the Chinese markets over the past two months, a stuttering global economy is suddenly realising that its main engine of consolidation and growth might just turn out to be a paper tiger. As this realisation dawns upon the global economy, panic has become the key word in the lexicon used by analysts’ the world over. Nonetheless, it is yet to be seen whether the possible reaction to the Chinese market collapse was based on unnecessary panic or justified fears. Without going into the intricacies of global markets, the above explanation does present of a picture of what may have triggered such a response. 

According to credible news reports, between June 2014 and June 2015, the Shanghai Composite Index saw a phenomenal rise up to 150 percent. Such a rally was fuelled by the entry of many ordinary Chinese people in the stock market for the very first time. According to reports, more than 40 million new stick accounts were opened in the past financial year. However, many of these new entrants began to buy stocks on borrowed money. Although Beijing has usually regulated such practices, the past five years have seen a relaxation of those regulations. But, earlier this year, authorities in Beijing became increasingly concerned about the unsustainable nature of its stock market’s rise and the consequent credit bubble. Although Beijing began to tighten limits on debt-financed stock market speculation before it peaked in June, what many experts saw thereafter was nothing short of a nose dive. 

In early July, they made aggressive efforts to prop stock prices. Those efforts seemed to bear no fruit. Unfortunately, even radical policy moves by Chinese authorities — which included ordering companies to buy their own stock and banning some executives from selling — weren’t enough to prevent further downslide. Moreover, in an unusual diktat on Sunday, Beijing allowed pension funds managed by local governments to invest in the stock market for the first time, potentially channelling hundreds of billions of Yuan into the country’s struggling equity market. China’s current economic situation is akin to a black hole, where repeated stimulus packages sent by Beijing seem to have no bearing on the larger malaise. Whether Beijing’s latest move has any bearing on the current situation is yet to be seen. 

More than anything else, however, the fact remains that the larger Chinese economy is struggling. Official figures show the Chinese economy growing at a 7 percent rate in the second quarter, which is the lowest in recent memory. Economists outside China, however, feel that Beijing has inflated its growth figures. Moreover, it is slightly disconcerting to note that Beijing’s decision to directly intervene in the stock market has tied the government’s reputation to  market performance. In the past two decades, China’s phenomenal economic growth has been based on its tremendous export capacity. With global demand on the wane over the past few years, it is clear that exports cannot fuel China’s growth in the long term and that it needs to make a transition to an economy based on domestic consumption. Whether Beijing has the stomach to push necessary reforms to make that transition is yet to be seen. 

As a result of events in China, commodity markets world over have taken a massive hit. According to news reports, Brent and U.S. crude oil futures hit six-year lows. Concerns on the already present global supply glut added to worries over potentially weaker demand from China. As the Bombay Stock Exchange (BSE) and rupee witnessed massive dips, the Reserve Bank of India Governor Raghuram Rajan said that India’s strong macroeconomic fundamentals are strong enough and that it possesses a large reserve of foreign exchange to withstand the effects of a Chinese meltdown. In a day, where the BSE plunged by more than 1000 points while the Nifty fell below 8,000, Rajan’s message is bound to bring some succour. Moreover, the RBI Governor had rightly predicted earlier that the current turmoil has been long-coming, with China only the last step in it.