The importance of a strong chinese equity market

25/01/2016 06:29 AST

A strong equity market carries benefits for China: (i) It provides a more attractive backdrop for IPOs, and for private equity financing, opening up a new financing opportunity for small and medium-sized enterprises which have more limited access to credit; (ii) it creates a better backdrop for privatizations, supporting the State-Owned Enterprise (SEO) reform process; and (iii) as share ownership has broadened over the course of the rally, it can also give some support to domestic consumption via a wealth effect, even if limited (equity ownership remains extremely low in China at less than 2 percent of household assets).

Policymakers are trying to strike the right balance. They want to prevent a stock market crash, which would not only pose a risk to economic growth, but also set back the progress in making the equity market a more important part of the economy, both as a source of financing for corporates and as an investment opportunity for savers. They will prefer, however, to help the market stabilize rather than to fuel another sharp run-up in valuations that could set the stage for a full-fledged crash.

Over its relatively short history, China’s domestic stock market has been prone to extreme fluctuations, partly because it has been closed to international investors. And although China’s stock market still plays a relatively minor role in its economy, both as a source of capital for companies and as assets for households, its importance on both sides has increased.

Last summer, the Chinese government adopted a number of administrative measures to halt the fall in stock prices after a correction that alarmed investors around the world. It is worth recalling that the correction at that time came after valuations had more than doubled over the previous 12 months, but it did not precipitate the fully fledged crash that some observers had predicted.

The People’s Bank of China (PBOC) has once again intervened to devalue the yuan, and once again some commentators are interpreting the devaluation as a signal that policymakers remain deeply concerned about the growth slowdown.

While some observers feel the Chinese authorities may seek to engineer a substantial depreciation to boost growth through exports — leading to currency wars that may disrupt global growth and the global financial system — our view is different.

We believe China’s policymakers will most likely stay the course. We would note that before the depreciation in August 2015, China’s currency had appreciated by over 12 percent on a real effective basis in the preceding 12 months. Furthermore, China had experienced some “hot money” outflows during the first half of the year, which also clearly influenced policymakers’ actions. Although the renminbi has experienced a modest depreciation, we do not feel the move is a precursor to a larger uncontrolled weakening, as feared by markets.

Arab News