Crash of Market in China

Reasons for Stock Market Crash in China and its
Implications
Introduction
China is the worlds second largest stock market in terms of market capitalisation, after USA.
Chinese stock market index had risen as much as 110 percent from November 2014 to a peak in
June 2015.
Ever since 12 June 2015, it has collapsed at an incredibly rapid pace. It has plummeted by well
over 20 percent, and more than 3 trillion dollars of paper wealth has been wiped out.
The value of this massive drop in the stock market is more than the GDP of Brazil and 20 times
the value of Greece debt.
The Chinese government did constituted a number of extraordinary measures to try to halt the
market's slide over the past month, but, to little effect.
Shanghai Composite index fell another 5.9 percent, bringing the market's total losses to 32
percent in less than a month.
Reasons for the Stock Market Crash
Chinese banks offer Wealth Management Products (WMP) for investment that promises the
security of a savings account with high returns. However, the banks, in turn, invest WMP funds
in ways that are much riskier.
About 30 percent of WMPs guarantee return of principal, and 70 percent are not guaranteed. But
a lot of ordinary investors believe that their investment is safe.
For this purpose, the banks use Trust Firms, called, Umbrella Trusts as conduits, to invest
money in funds that piles up capital directly into the stock markets.
Besides the banks making indirect investments into stocks, a lot of common people started
buying stocks with borrowed money, a practice, known as "trading on margin."
Earlier the Chinese government had imposed a lot of restrictions on "trading on margin," but the
authorities have gradually loosened the regulations since 2010.
In order to prevent speculative investments, certain safeguards were instituted by the

government, like only half of the invested funds could be borrowed and also restrictions on
which stocks you could buy and how long the money could be borrowed, etc.
Nonetheless, common people of China continued to find unethical and creative means to invest
borrowed money into high risk - high dividend funds. This practice of making investments with
borrowed funds is known as leverage.
So, borrowed money flooded into the Chinese stock market between June 2014 and June 2015,
helping to push stock prices up 150 percent.
Not taking into account the money invested through the back-door methods, during this period,
the amount of officially sanctioned margin trading in the Chinese stock market ballooned from
403 billion Yuan to 2.2 trillion Yuan.
In April, Chinese authorities began to institute corrective measures to restrict speculative
investments through margin trading and all other forms of leveraged investments, which had
created an artificial bubble in the stock market.
The regulators cracked down on banks using WMPs to fund stock market investments and stock
brokers using Umbrella Trust to help their customers evade limits on margin trading were
banned.
The government's toughest measures came on 12 June 2015, when China's securities regulator
announced a new limit on the total amount of margin lending stock brokers could do, while also
reiterating the ban on illicit margin trading through mechanisms like umbrella trusts.
Chinese stocks have been falling ever since that June 12 announcement.
In a nutshell, Chinese government relaxed a rule that had earlier limited margin trading to the
wealthy people only. So, 20 million people opened stock market accounts in 2015 alone and
indulged in margin trading with leveraged investments. The borrowing magnified their gains as
the market rose.
When the Chinese government restricted margin trading, the stock began to fall and the leverage
magnified their losses too.
Implications of Chinese Stock Market Crash
Short-Term Implications
Many ordinary Chinese people had used their complete lifes savings and in some cases,
mortgage their homes to invest in stocks will be rendered paupers overnight.
These novice investors, many of whom have limited education and financial savvy, may be
perplexed and angry if their savings get wiped out. This could create a broad grassroots backlash
against the authorities and may result in social unrest and could even lead to a revolution or a
coup.
The investments made into speculative real estate projects or business ventures, has invariably
created an artificial bubble in those spaces also. The bursting of bubble in these spheres would
further compound the losses of the investors.
Mid Term to Long Term Implications
In the mid-term and long term scenario, the crashing of the stock market may herald a Chinese
economic collapse in 2015 and the early indicators of the same are given below:
Slump in the Industrial Production
Industry has been the major driving force behind the Chinese economic growth. In February,
industrial production growth has receded to just 6.8%. It was 18.5% during the pre-global
recession era in February 2007.
Fixed-asset investment (the purchase of any physical asset) is a leading indicator of future
manufacturing activity, is also down by 4% from last year.
Consumer Spending Fallen Drastically
In order to give an impetus to the industrial growth, the domestic consumer spending needs to be
high, so that reliance on foreign export can be reduced.
However, due to the market uncertainties, the retails sales in the present times in China are at its
slowest pace in the last nine years.
Housing Market in China is Collapsing
The housing market in China makes up about 25% of the economy. Due to the above mentions
reasons, as also, when investors will default on what they have borrowed, as scrutiny in the
housing market grows, the real estate prices will tumble.
A latest survey regarding real estate trends in Chinas largest cities shows that 61 out of the 70
major city centres have experienced a price declines.
Chinas National Debt Soaring

Chinas present debt-to-GDP ratio stands at 282%. The same is considered to be extremely high.
In need to be further noted that, these debt calculations not only include government balances,
but also those of households and non-financial corporations.
Connecting with the previous point, it needs to be noted that half of all the said loans are linked,
directly or indirectly, to Chinas overheated real-estate market, which is slumping.
Hence, an economic depression in China, causing it to default on payment of sovereign debts,
may trigger another Global economic meltdown as it happened in 2008.
Dilemma of the Chinese Economists
Debt levels when compared to national output are extremely high and a
major component of the Chinese economy, i.e. real estate market is in a
bubble territory.
It is cardinal for the Chinese authorities to rein in debt levels so that it does
not become unsustainable; however, the declining real estate market is
suppressing the growth in the short-term.
Conclusion
China's was an isolated stock market. It had no impact on the world markets, when China stock
indices doubled and tripled in a very short span of time. So, a crash in China's markets is
unlikely to result in a major impact on other emerging markets.
As regards India, a crash in Chinese stock markets could have no direct negative impact on
India's stock market.
However, indirect impact of Chinas economic slowdown could be that the consumption of
goods and services will decline, which would adversely affect developed economies like the
USA. After all China is the largest consumer of a number of goods and commodities in the
world.
A major reduction in the consumption of goods and services, coupled with Chinas inability to
honour the debts may herald another world economic recession.
Some economic analysts also feel that an economic downturn in China could mean increased
investments coming into India, provided we utilise the opportunity well and execute the
economic and systemic reforms being promised to the investors in double time.
Whatever be the case, the next two years, i.e. 2015 & 2016 are going to be highly significant
from the point of view of opening a new chapter in the economic history of India, which even as
per the IMF Report is at a cusp of upward economic trajectory and will overtake China in its
projected growth.

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Reasons for Stock Market Crash in China and its

In order to prevent speculative investments, certain safeguards were instituted by the

Chinas National Debt Soaring

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