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China’s stock market has plunged by more than 15% in the 2nd half of August, after the earlier 30% decline in June and July. The government responded on August 25th with another interest rate cut of 0.25 percentage points and a cut in the required reserves ratio of large banks of a further 0.5 percentage points. The situation is volatile and it is too early to tell if these measures will stabilise China’s stock market, or if the government will be pushed into more drastic measures such as restricting stock sales or even suspending trading. This note focuses on the potential spill-overs from the drop in the Chinese stock market.
Source: Yahoo Finance
Note: Closing price adjusted for dividends and stock splits. Last price is for August 25th.
The impact of stock market fluctuations on GDP growth in China has historically been quite low. Stock market investments represented about 10% of household assets at the end of 2014, with less than a tenth of households owning stocks. As a result, the negative effects of lower stock market prices on consumption should be small. The proportion of new equity issues in corporate financing is also quite low. There are some corporate loans that were issued using stock market shares as collateral, but they represent less than 1% of China’s total lending to business.
Simple statistical correlation analysis suggests that a 40% decline in stock market prices could lower GDP growth by up 1.3 percentage points. Using Euromonitor Macro Model estimates, a persistent 40% decline in Chinese stock market prices would cause GDP in China to drop by up to 1% in 2015-2016 relative to our current forecast. Other economies in the Asia-Pacific region would see their GDP decline by 0.2-0.4% relative to the baseline forecast. So if the recent stock market crash was purely the result of irrational investor pessimism or a reversal of the previous excessive optimism, the effects on the real economy would be moderate.
Source: Euromonitor International Macro Model
Note: % decline in GDP level relative to the baseline forecast in 2015-2016.
The Chinese stock market correction has also led investors in other markets to reconsider current valuation levels in light of lower growth prospects in BRICs and the US. Stock markets in the US and Eurozone have declined by around 10% during the month of August (as measured by the S&P500 and Euro STOXX indices on August 25th). The most probable scenario as of today is that any further price declines will be limited and temporary, especially taking into account likely policy reactions such as a delay in Federal Reserve interest rate increases. In this case, global spill-overs from other stock markets will also be quite small.
A less likely, more negative, scenario is that the current global stock market turbulence is a signal of a much stronger deceleration in China’s economy, going deeper than the suspicions of many analysts that China’s growth rate is closer to 5-6% than to 7%. In the worst case, a Chinese “hard landing” would lead to declines in the output level in other Asia-Pacific economies of 2-4.5% in 2015-2016 and of 0.5-1% in 2015-2016 for other emerging market economies. However, at this stage this scenario still sounds excessively pessimistic. China’s economy will continue to slow down. Its true growth rate is probably significantly below that reported in official statistics. But as of now, the spill-over effects from the Chinese stock market decline are unlikely to cause big negative revisions to the global economic outlook.