China’s move to cut interest rates in the aftermath of the biggest stock sell-off since 1996 brings focus to a debate among economists about the links between asset prices and growth in the world’s second-largest economy.
In a scenario that has played out in developed nations from the U.S. to Japan, an asset-price tumble hits household wealth, spurring them to rein in spending and hurting the economy. In China, it may not be so simple: The typical wealth effect dynamic may operate differently in a nation where retail investors dominate equity trading and stock-market sell-offs prompt monetary easing, as it did on June 27 when the central bank announced it would cut interest rates.
A majority of nine among 17 economists surveyed June 18-24 judged that a 30 percent drop in major equity benchmarks within 30 days would have only a “negligible” effect on growth. Asked about the implications of the surge in shares over the past year, five said it was a “net positive” for the economy, five said a “net negative” and eight were neutral.
One theory: soaring equities may be bad for the economy because consumers are encouraged to hold off on spending and put their money in the market instead. A doubling in China’s main indexes in the past year coincided with the weakest economic growth in a quarter century.
Underscoring the challenge confronting analysts, the People’s Bank of China-backed Financial News reported Wednesday that there probably wouldn’t be any further reductions in interest rates or reserve requirements this month. Three days later, the PBOC announced it was cutting the benchmark lending rate by 25 basis points to 4.85 percent and the deposit rate by a quarter percentage point to 2 percent. Required reserve ratios for some lenders also will be reduced.
The Shanghai Composite Index fell 3.3 percent Monday, taking declines from its June 12 peak to more than 20 percent and ending China’s longest-ever bull market.
For some, the economy’s slowdown is inexorable, as President Xi Jinping and Premier Li Keqiang recalibrate -- in fits and starts -- away from reliance on investment and toward consumption and services.
“Growth will trend down, whatever direction the equity market will move,” said Daili Wang, a Singapore-based economist at Hanna-Roubini Global Eco Ltd., a part of the research group founded by Nouriel Roubini.
In the view of Lynn Song at China Merchants Securities International Co. in Hong Kong, the stocks rally over the past year was “positive in terms of the wealth effect, but negative as valuations far exceed fundamentals and a sharp correction could lead to a significant shock.”
Tangible effects from the equity rally have been difficult to isolate in economic data so far. While readings such as industrial output stabilized in May, most attributed that to monetary easing and a leadership-backed debt swap for local governments to keep infrastructure spending afloat.
Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong, says overseas investors widely perceived the stocks surge as a bubble, while domestic investors viewed it positively -- driven by the perception of government support. He sees a negative wealth effect at work, with households delaying consumption to speculate.
At the same time, the rally has been useful for companies that have raised funds in greater numbers from the stock market. PBOC Governor Zhou Xiaochuan in March highlighted those benefits.
“The bullish market can be interpreted as a reallocation of household savings to the stock market, to reduce corporate debts through the debt-equity swap, resulting in the reshaping of China’s overall balance sheet,” Shen wrote in a note to clients last week. “This is consistent with the intentions of top-level policy makers.”
Two-thirds of economists surveyed expected the government to take advantage of current valuations to increase asset sales and accelerate reform.
Perhaps the clearest link between the stock market in China and the real economy is the determination to underpin sentiment when it’s threatened by market volatility.
The latest monetary easing “can have a ‘one stone two birds’ effect,” said Liu Li-gang, Australia & New Zealand Banking Group Ltd. chief China economist in Hong Kong. “It allows the PBOC to ease policy to boost the sluggish economy while sending a policy signal that authorities do not want to see a bear equity market either.”