Chinese Stock Market Crash: A Bad Omen for China?

Executive Summary

The two major stock market indices in China have plummeted more than 30 percent over the past month. Similar-sized declines in the American stock market surely would portend bad omens for the U.S. economy. However, the Chinese and American economies clearly have different structures. Specifically, the Chinese economy is largely bank financed, unlike its American counterpart where equity markets play a more important role in corporate finance, and equities constitute a smaller share of household net worth in China than they do in the United States.

Consequently, growth in business fixed investment (BFI) spending in China may slow in coming quarters, but it is unlikely to collapse, based solely on the recent decline in Chinese share prices. Similarly, growth in Chinese consumer spending, although it may slow somewhat in coming quarters, is not likely to weaken significantly due to the swoon in the stock market. Although we look for the overall rate of real GDP growth in China to trend lower in coming quarters from the 7.0 percent year-over-year rate that was registered in Q1 2015, we do not believe that the collapse in Chinese share prices over the past month portends a sharp downturn in the Chinese economy.

Chinese Stock Market Has Swooned over the Past Month

Media attention has been focused on Greece over the past few weeks, so many readers could be excused if they have not been paying attention to recent developments in China. The Shanghai Composite stock market index has plunged 32 percent since peaking on June 12, and the Shenzhen Composite index has nosedived 40 percent over the same period (Figure 1). In less than one month, 24 trillion Chinese yuan (about $4 trillion) has been erased from the market capitalization of the Chinese stock market.

We are not experts on the Chinese stock market, so a detailed discussion about its meteoric rise and subsequent nosedive is beyond the scope of this report. However, the eye-popping rise in margin buying—margin debt rose by tenfold last year and it doubled again the first six months of this year—undoubtedly helped to fuel the sharp increase in Chinese share prices over the past two years. The sharp decline in equity prices in recent weeks may reflect, at least in part, an unwinding of this previous margin buying.

We are more concerned in this report about the implications of the recent stock market collapse for the outlook for the Chinese economy. Won’t the loss of financial wealth have deleterious consequences for consumer spending in China? Could business investment spending, which had been weakening already, soften further due to the rise in the cost of capital in recent weeks? Does the downturn in the Chinese stock market signal that a recession in China is imminent?