Lessons for India from the Chinese stock market crash

Investors should be wary of irrational exuberance when betting on the markets.

 |  3-minute read |   09-07-2015
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There is a lesson or two for India to learn from the Chinese stock market crash. The first is that any developing country needs to curb its irrational exuberance as it moves into a high growth phase. Second, it should be modest enough to accept the reality when the economy slows down. The Chinese stock meltdown – where the country’s bourses lost $3.25 trillion since June 12 – was obviously a creation of the Chinese themselves. The bull run that was witnessed in the Chinese markets for a year starting June 2014 had little to do with the country’s economic fundamentals. Even as prices of Chinese stocks grew 150 per cent during the period, the country’s GDP was de-growing, and during the first quarter of 2015, grew only 7 per cent compared to 7.3 per cent in the previous quarter. The bull run, it has now become evident, was a result of "margin trading" where retail investors used borrowed money to pile up shares for themselves. The result of this was that the Chinese stock markets became overvalued, and detached from the reality of the country’s economy. When reality set in, it wiped out all the temporary gains made by investors, leaving them in the lurch, and jolting markets across the world.

To assume that the stock market meltdown heralds the beginning of the end of China’s economic prosperity is to miss the wood for the trees. The world’s second largest economy is still a manufacturing power house and will remain so for many years. However, as a World Bank report recently suggested, the country has to accept that it has reached a critical phase in economic and social developmental path. To sustain solid growth and rebalance its economy, China needs to increase the efficiency of new investments and widen access to finance, the bank said. Was the country stoking a giant asset bubble? If it has been, its hour of reckoning has arrived.

The Indian stock markets, too, had shown such exuberance, when the bourses saw a sustained bull run, right from the days when pre-poll predictions pointed to an overwhelming majority for the BJP in the Lok Sabha elections, up to the early part of this calendar year. However, in April and May, stock markets plunged into the red zone on uncertainties regarding retrospective taxation, rising oil prices, and prospects of weak corporate earnings. That correction needs to be welcomed. For the past two days, the markets have seen huge falls, with the benchmark Sensex falling nearly 500 points on Wednesday and 114 points on Thursday. That is more psychological, and will recover over a few days. Moreover, Indian markets have far less individual investors, and are better regulated than China, so a major impact of the Chinese meltdown is ruled out here. On the other hand, India is slated to gain in the short term from the slump in commodity pricing, and from becoming more attractive to investors compared of China.

But these gains for India can be as short lived as the Chinese market meltdown (The Chinese markets are already rebounding, with the CSI 300, an index of the biggest listed companies in Shanghai and Shenzhen, gaining 6.4 per cent on Thursday). Indian investors should now know that asset bubbles that are built on exuberance and not on a sound economy can land them in trouble. It also provides an opportunity for the Modi government to enhance work on fundamental issues that can aid India’s growth, than to expect indirect gains from a crisis in the neighbourhood.

Writer

MG Arun MG Arun @mgarun1

The writer is Deputy Editor, India Today.

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