China’s Stock Market Collapse

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By Jayati Ghosh, Professor of Economics and Chairperson at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. Cross posted from Triple Crisis


The recent rout in the Chinese stock market – and the Chinese authorities’ increasingly panicky responses to it that temporarily halted the decline – may not seem all that important to some observers. Indeed, there are analysts who have said that this is just the typical behaviour of a still immature stock market that is still “froth” in the wider scheme of things, and not so significant for real economic processes in China. After all, the Chinese economy is still much more state-controlled than most, the main banks are still state-owned and stock market capitalization relative to GDP is still small compared to most western countries, with less than 15 per cent of household savings invested in stocks. Most of all, there is the perception that a state sitting on around nearly $4 trillion in foreign exchange reserves should be rich enough to handle any such exigency without feeling the pain or letting others feel it.

But this relatively benign approach misses some crucial points about how the Chinese economy has changed over the past few years, as well as the dynamics of this meltdown and its impact in the wider Asian region. Since the Global Recession, which China weathered rather well, there have been changes in the orientation of the Chinese government and further moves towards financial liberalization, which were rather muted before then. And these resulted in big changes in borrowing patterns as well greater exposure to the still nascent stock market, in what have turned out to be clearly unsustainable rates.


Some of this has to do with real economic processes. The export-led strategy that had proved so successful over two decades received a big shock in 2008 and pointed to the need to generate more domestic sources of demand. But instead of focussing on stimulating consumption through rising wage shares of national income (which could eventually have threatened the export-driven model) the Chinese authorities chose to put their faith in even more accumulation to keep growth rates buoyant. So the “recovery package” that the Chinese government out in place in the wake of the Great Recession of 2008-09 was essentially one that encouraged more investment, in an economy in which investment rates already accounted for close to half of GDP. The stimulus measures encouraged provincial governments and public sector enterprises to borrow heavily and invest in infrastructure, in construction as well as in more productive capacities even though it was becoming evident that there had clearly been excessive capacity creation in the previous period. They also encouraged much more active interest in the real estate sector, which became the driver of China’s growth in the recent period.

Much of this investment was on the basis of money borrowed from the public sector banks that had dominated the financial landscape in China. But as the real estate sector started showing signs of a major bubble, banks were restricted from putting much more money into such loans, and there were also caps on their deposit and lending rates. This encouraged the growth of a “shadow banking” sector that emerged as a form of regulatory arbitrage, as various trusts and non-bank financial institutions created “wealth management products” to offer higher returns to savers and provided financing for real estate and construction, fuelling the property boom. Surprisingly, the authorities turned a blind eye to such developments – and even implicitly encouraged them, allowing banks to lend money to such financial institutions and thereby get indirectly implicated in this process.

The result has been a dramatic explosion of debt in just a few years. Between 2007 and 2014, total debt in China (in absolute Renminbi terms) went up four times, and the debt- GDP ratio nearly doubled. At around 282 per cent of GDP, this makes debt in China relatively much larger than in, say, the United States. Corporate debt increased to reach 125 per cent 2 of GDP; provincial governments are also highly leveraged for infrastructure investment; and debt held by households has gone up nearly threefold to a hefty 65 per cent of GDP. Fully half of the debt (much of it coming from the unregulated shadow banking institutions that were allowed to flourish) was oriented directly or indirectly towards the real estate market and housing finance, fuelling property bubbles in major Chinese cities that began to burst around a year ago. ....................(more)

http://www.nakedcapitalism.com/2015/08/chinas-stock-market-collapse.html