With close to half of China’s listed firms announcing trading halts on Wednesday to protect themselves from the carnage—the market has fallen 31.7% in the last 4 weeks—and all 3 futures index products for July delivery falling by their 10% limit, the Beijing ‘put’ appears in trouble. Stock market collapses are par for the course across the world, but when this takes place despite 3 interest rate cuts this year, government directives to mutual funds and state pension funds to buy stocks—the state-owned margin trading service provider also provided $42 billion in credit lines to 21 brokerage firms on Wednesday—it is no ordinary situation since, till now, the majority view has been that, no matter what, China’s government had enough levers at its command to ensure a smooth landing for the economy. From the heady 9.4% average GDP growth between 1997 and 2006, growth rose to 14.2% in 2007 but has been collapsing steadily, from 9.8% in the December 2010 quarter to 7% in the March 2015 quarter—PMI has been below 50 in 2 of the last 6 months and just a bit above 50 in the rest. Indeed, a panicky government has also allowed traders to use property—itself a big bubble—as collateral for margin finance, and has been urging companies to buy back their own shares.A big stock market collapse could have larger implications at a time when the country’s debt burden —mostly China Inc’s debt—has skyrocketed, from 150% of GDP in 2008 to 300% right now. Indeed, the government has curbed new IPOs in an attempt to stabilise the market—ironic, since the pumping up of the market was aimed at creating an alternative source of finance for debt-laden firms. Over the last year, several Chinese entities have defaulted on global loans, and the bubble in the property market has raised concerns over the safety of loans made to the sector—a large part of local government debt, in turn, is invested in property. A BNP Paribas analysis last year pointed out that real estate investments were up to 15% of GDP, up from 10% in 2008; and that the market value of floor space under construction was up from 65% of GDP in the 5 years to 2008, to around 155% of GDP today—in other words, a huge property overhang on debt.
According to Ruchir Sharma who heads emerging markets and global macro for Morgan Stanley, if China can’t stop the collapse, investors could pull out funds as the weight of the debt will undoubtedly put a cap on future growth as well. Sharma reckons a record $300 billion has already left China this year. He argues that of the 33 countries which had extreme credit booms of the type China has had, 22 suffered a credit crisis in the next 5 years; not one got away without either a crisis or a major economic slowdown, and this includes the likes of Japan, Taiwan and Korea who had many of the safeguards mentioned in the context of China, such as large forex reserves. A collapse in China, or even a steady slowing to 5-6% growth levels will not only have serious consequences for global growth, it will have immediate consequences for India. A Credit Suisse research note points out that, thanks to the collapse in Chinese steel prices—$152 per tonne over FY15 prices—Indian steel firms will be badly hit (they have bank debt of $42 billion) and the only solution is to shut down capacity. The debt of the Indian steel sector, it is important to keep in mind, has been flagged by RBI as one of the biggest dangers to Indian banks.