With Chinese stock prices falling by 30 percent from their mid-June peak, China’s recent stock market performance has been causing panic among investors. Despite policy efforts to stabilize the market, stock exchange volatility is likely to place additional pressure on the country’s already struggling economy. We are encouraging our clients to monitor this situation very closely, as ripple effects will reach beyond the stock markets and could affect the overall financial ecosystem in China.
China’s stock exchanges have suspended initial public offerings in an attempt to boost demand for listed shares. Twenty-one securities brokerages have also pooled their own funds, creating a $19 billion fund to invest in large stocks. While major players can expect government loans or bailouts, individual or small retail investors who lack access to special government assistance are more likely to suffer losses. With Chinese households holding about 20 percent of equity assets in the market, preventing the potential loss of returns on these investments will be difficult in the event of a market crash.
FSG does believe that China won’t grow at 7 percent in 2015, and the likelihood of the downward scenario (Chinese financial crisis) has, essentially, gone up.
Implications for Heads of Asia-Pacific and General Managers for China
- Gauge market sentiments: FSG clients are strongly advised to monitor the government’s attempts to raise share prices and the impact of government policy on investor sentiment. The next two weeks will be critical as the Chinese government tries to restore business and investor confidence through proactive measures to prevent share prices from falling.
- Re-evaluate distributor financial stability: As the Shanghai Composite Index tumbles, stock and real estate investments based on rampant margin trading activities are becoming even harder to govern. Retail investors are also likely to curb big-ticket expenditures as they see their portfolio value evaporating. Smaller regional distributors might be even more troubled by limited credit availability, which would further disrupt multinational companies’ plans to access regional markets in China.
- Assess risks and build contingency plans: Although China’s turbulent equity market might not be influential enough to completely derail the government-managed “New Normal,” a stock market crash is still likely to affect the real economy by hurting domestic demand and causing reforms to be delayed. As China’s economy slows, multinationals must optimize resource allocation and prepare exit strategies in areas where business could be most affected by China’s financial instability
Implications for Heads of International
- Re-assess China’s role in your APAC/Global portfolio: As you may have or are in process of kicking off your strategic planning session for 2016, we would encourage you to reconsider the role you expect China to play from the stand-point that (a) The market sentiment will continue to be challenging (both macro and micro), hence any new investments need additional analysis; and (b) we do expect the government to continue to tilt towards local companies which will dampen the momentum for multinationals in the long run in China. This will lead you to build an effective government engagement strategy in your long-term plan for China.
- Informal lending could be on the rise: If you were thinking of increasing your investments in China, we would recommend understanding how these developments will impact your suppliers and channel partners’ informal lending activities on the ground. You need to ensure you build a robust evaluation mechanism on the financial stability of your customers and channel partners.
In terms of implications for President Xi’s reform agenda, we think that the transition from investment-led to consumer-based model is critical to long-term sustainability of economic growth and Chinese development model. With increase in bad debt in the system – even without a financial crisis, diminished consumer confidence could exacerbate the slowdown.