China’s market plunge puts economy at risk

The ongoing fall in China’s stock market puts the country’s entire financial system and structural reform agenda at risk, according to Axa Investment Managers and Schroders.

China’s market plunge puts economy at risk

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Structural reform threat

According to Yao, the Chinese government believed the bull run in the domestic equity markets since late last year could help achieve a number of strategic goals, including financial liberalisation, debt deleveraging and reforms in state-owned enterprises.

These efforts could now be undermined.

“Although some corrections can be tolerated after the stellar rally, the concern is that continued collapse of the market, as we saw in recent weeks, could quickly degenerate into a full-blown crisis.

“Once the damage is done, the equity market could take years to recover – a length of time China cannot afford to lose for its structural transformation,” Yao added.

Botham of Schroders echoed more or less similar views. “The People’s Bank of China (PBoC) is capable of providing ample liquidity to keep credit markets going,” Botham said. But providing liquidity will work against efforts to tackle debt sustainability for local governments and state-owned enterprises, and also the recapitalisation of banks.

Market stabilising steps

Chinese authorities have taken a slew of measures over the last few days, which include suspension of IPOs and cuts in interest rates and banks cash reserve requirement ratios.

Moreover, authorities have asked a group of 25 mutual funds to invest in domestic stocks and hold them for at least one year.

The PBoC has also decided to provide liquidity support to the China Security Finance Corporation, an institution that oversees margin financing of brokers, in a move to stabilise markets.

“Among the announced measures, the one that carries the most punch is the one involving the joint operation of the PBoC and CSFC, in our view,” said Axa’s Yao.

“Some market participants called it the big bazooka, as it potentially opens the door for an indirect intervention by the PBoC, via the CSFC.

Yao, however, believes China’s central bank “would not want to risk its balance sheet and credibility by fully committing itself to an equity market bailout”.

Axa Investment Managers continues to have an underweight call on mainland shares.

In mid-June, Blackrock and Morgan Stanley were among the fund houses warning about a potential bubble in China’s equity market. The Shanghai Composite Index has fallen about 25% over that time.

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