The contagion that many feared would spread from a tanking Chinese equity market a fortnight ago, to other asset markets, particularly emerging market stocks, didn't quite materialise. Asian stock markets and their currencies have stabilised after an initial knock-on impact while some like the rupee and the Thai baht actually appreciated. With the Greek impasse out of the way as well, the world seems a calmer place at least for the near term.
The reason for this, at least superficially, does not seem too difficult to fathom. The slew of quantitative controls, the quintessence of heavy-handed state intervention, stemmed the fall and actually led to a reversal in the equity markets. Just to remind readers, the Chinese central bank cut key policy rates while the government suspended trading in collapsing shares and pumped cash into the market, leading to a short rally that lifted the key Chinese stock indices by about 10 per cent from the bottom they had reached.
However, seasoned international investors should have seen through the flimsiness of these measures, ignored them as temporary and desperate and continued to carry the China contagion to other markets. This didn't happen for a number of reasons. First, foreign participation in the China asset bubble was limited. The investment bank UBS estimates that foreign investors own just one per cent of the Chinese market value of roughly $8.5 trillion. The percentage would have been somewhat higher in the earlier part of the year but foreign hands seem to have been prescient and sold off. Thus the need for foreign investors to fund their losses in the source or the epicentre of the contagion - the classic wave through which these market domino effects spread - was limited.
Besides, the fact is that the sell-off did not come as a sudden wake-up call that China's fundamentals were weak and not getting better. The whole world, Chinese policy-makers included, have been aware of China's slowing economy for three to four years now. This has been priced into things like commodity prices and commodity-plays like the Australian dollar way before the China stock bubble inflated and then deflated. The global investment community thus seems to have treated the sharp rise in China's prices and subsequent fall as a somewhat naive Ponzi game confined to China that the government played with domestic retail investors for several reasons. This could include the need to sell stakes in some of the weaker state enterprises or simply to appease a political class that also happens to be the biggest stakeholder in the stock market.
Perhaps a more important question that needs to be raised in this context is whether the Chinese economy will take a hit because of the moderation in stock prices. Textbooks would point to the so-called wealth effect that could drive domestic consumption up or down with the vagaries of the stock market. By US standards, stock ownership is low with about one out of 30 Chinese with some exposure to stocks compared to seven in the US. Moreover, the short-lived nature of the market rise and fall suggests that wealth effects may be limited on the downside, especially since the market still remains strongly higher over a year ago.
The behaviour of the rupee during the China sell-off might have lessons for the future, particularly about the impact of other global 'shocks' that might follow. With the exception of some intra-day losses on the worst day of the China debacle, the rupee stayed flat and then gained traction. It was as if the market had chosen to ignore the short-term panic and focused on the medium-term benefits such as falling commodity prices and a switch in fund flows from China to India. Could this mean that the Indian currency is slowly acquiring safe-haven status among emerging markets? Clearly, improved macroeconomic fundamentals like a shrinking current account deficit and a large pile of reserves have acted as positives. That said, issues like a growing pile of un-hedged foreign currency debt and foreign ownership of local debt are risks that we cannot take our gaze away from.
Abheek Barua is chief economist, HDFC Bank. Bidisha Ganguly is Principal Economist, CII
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
