What are the real risks of a China stock market bust? | FT Alphaville

What are the real risks of a China stock market bust?

There were 385,000 new share trading accounts opened in china on Monday alone, taking the total past the 100m mark. The previous week the number of new accounts was about 1.5m.

On Wednesday, China’s benchmark index took another nosedive, closing down 6.5 per cent, after Beijing took its most decisive step yet to slow its runaway train of a stock market, tripling the stamp duty tax on share transactions. Even after the fall, that still leaves the index up around 50 per cent this year.

Shanghai Composite
But after the 9 per cent fall in the Shanghai Composite triggered falls in stock markets around the globe back in late February and early March, received wisdom is now that investor sentiment globally should be more resilient to the machinations of the notoriously volatile, and still relatively undeveloped, Chinese market.

What about the real economy? Would a serious plunge for China’s toppy stock market have knock-on effects in its economy, with broader global repercussions?

Presciently, Qing Wang and Denise Yam on Tuesday considered just that question at the Morgan Stanley Global Economic Forum.

“On examination of household and corporate exposure to the stock market, we conclude that the negative ‘wealth effect’ on consumption would be moderate and financing conditions for corporate investments would be unlikely to deteriorate significantly should the A-share market plunge by 30% from current levels,” they argue.

“We believe that the direct economic impact would be manageable in the event of such a burst. Hence, the fear of a complete economic meltdown in China as a result of a potential burst of the stock market bubble is unwarranted at the current juncture, in our view. Nevertheless, a major correction of the A-share market could well result in significant contagion to global markets, as seen during February’s short-lived correction. However, to the extent that any such global sell-off were driven by concerns about a stock-market-correction-triggered-recession in China’s real economy, it would likely prove overdone, in our view.”

But there’s a warning. They think that should the current trends continue the potential severity of the fallout from a stock market bust increases significantly.

“Should the value of households’ stock holdings double from current levels to 40-50% of GDP, the potential negative ‘wealth effect’ on consumption would increase and the negative impact of a major stock market correction on consumption and overall growth would become more significant.

“More importantly, with potential returns from investing in the stock market substantially and persistently higher than those from traditional investment activity, not only households but also the corporate sector could be tempted to leverage up with money borrowed from the banks to invest in the stock market.”

That would leave the banks more exposed to the stock market, and the impact of a major correction magnified through the credit channels of the banking system.