Assessing the Global Impact of China's Fluctuations

Wild fluctuations on the Shanghai and Shenzen exchanges - vast sums being made or lost by individual retail investors has caused concerns of an equity bubble bursting. But how far would such an eventuality resonate globally? 

In the year leading up to June 12th, the Shanghai Composite index more than doubled, before taking a 12 per cent fall. Much of this decline, besides being an effective warning against excessive share buying, can be pinned to factors such as a new regulation on 'margin lending' - the use of borrowed cash to fund securities. 

But the efficacy of such warning signals is limited as Chinese share price fluctuations are not a reflection of what is happening with the country's economy. In spite of of the mushrooming of Chinese stock markets, they do not hold the same weight as US stocks as far as influencing the global investor climate is concerned; neither the catastrophe unfolding in Greece nor Chinese share price storms have touched the Vix index of implied US share price volatility. 

Share market volatility in China can also be interpreted as an offshoot of economic stabilisation, as the Asian nation moves away from exports, towards domestic private consumption and market liberalisation. Furthermore, should price falls get out of hand, the feeling is that Chinese authorities will become involved.

Head of research at Ashmore Investment Management, Jan Dehn, considers the German Bunds sell-off is of far greater interest to investors than movements in China, mainly because the former was not anticipated, not priced and is of far greater significance as a financial barometer for occidental debt. China’s fundamentals, by contrast, are in much better shape, Mr Dehn feels.

The key concern in all this is that an extension of Chinese share prices may, sooner or later, impact on household spending and undermine economic growth. Internal volatility reflects badly on what the nation has to do to rebalance its own economy and raises worries about how financial liberalisation in China will play out.

A relaxation on the rules of ‘margin lending’ and a partial clampdown on shadow banking has strengthened the Chinese stock market over the past 12 months. It has allowed firms with heavy debt to move towards equity financing, to the approval of Chinese authorities.

These same authorities must now try to negate potentially damaging fallout from the bursting of an asset bubble. At the same time, Beijing is moving to prepare China’s finances for global integration to draw overseas investment.

George Magnus, economic adviser to UBS, says: “This is a time when China is trying to attract foreign capital…. If volatility were to increase and it became more of a cowboy market with sharp daily moves and a high sense of unpredictability, it might restrain foreign investors’ willingness to commit capital.”

While interesting to watch from afar, the rollercoaster nature of the Chinese share market may yet involve global investors to a far greater degree.