25 Aug 2015

China financial crisis: the key questions

Following China’s “Black Monday” jittery global financial markets begin to recover – but do we all need to start worrying about China?

China’s central bank cut interest rates on Tuesday in a bid to stimulate growth in its struggling economy.

Lu Lei, the head of the research office at the People’s Bank of China, said the borrowing costs for Chinese companies were still rising after adjusting for inflation, and the 0.25 percentage point cut in interest rates to 4.6 percent should temper that.

The move follows a near 9 percent dive in Chinese shares on Monday – the worst daily performance since 2007.

In what the official Chinese news agency described as “Black Monday”, exchanges gave up all the gains made from Beijing’s unprecedented stock market rescue in July, in which hundreds of billions of state dollars were deployed following a turbulent month, propping up the market.

China’s economy has been growing exponentially since a period of rapid industrialisation in the 2000s, but recent weak manufacturing and export figures from China have indicated the economic powerhouse may be running out of steam.

What happened in 2007?

In what was dubbed China’s “Black Tuesday” at the time, the Shanghai stock index dropped 8.8 percent on February 2007, its biggest one-day drop in a decade.

The resulting panic saw the New York Dow Jones have its biggest day drop since the 9/11 attacks.

A domino effect took hold and markets across Asia plunged the following day, with India, Singapore, Japan, South Korea and Hong Kong all seeing dramatic losses – all in the run up to the global financial crisis that took hold of the markets the following year.

Why did Chinese share-drops spread globally then?

China’s extraordinary economic rise drove increased demand for commodities worldwide. When the stock market crashed in 2007 investors were panicked worldwide because of the implications for global demand.

However, traders at the New York Stock Exchange were criticised at the time for the drastic reaction to China’s crash.

The Shanghai stock exchange was only established in 1990, so the market is considered immature compared to the rest of the world, making it more likely to experience peaks and troughs.

Could that happen now?

Despite worries over Chinese growth triggering a global sell-off, markets across the world showed gains on Tuesday, suggesting that the financial panic outside China could be calming.

Tuesday’s interest rate adjustment by China’s central bank saw the United States Dow Jones jumped 300+ points and the pan-European FTSEurofirst 300 index jumping 4.2 percent, recouping the bulk of the 5 percent-plus it lost during Monday’s chaos.

Germany’s DIHK Chambers of Commerce said the situation on China’s stock exchange caused “worry” but not “alarmism”

He went on: “The trigger of the current Chinese crisis is actually a positive one: the good economic situation in the United States. Markets are withdrawing from China to invest in U.S. market as a result of low interest rates.”

What does it mean for the UK?

The volatility in global markets has prompted speculation that rate-setters on the Bank of England’s Monetary Policy Committee (MPC) may want to push back the timing of any interest rate hike.

Paul Hollingsworth, UK economist at Capital Economics, said: “[China’s crash] provides the more cautious members of the MPC with another reason to hold fire on voting to raise interest rates.”

However he added: “Although the UK has clearly been caught up in the recent meltdown in global financial markets, we doubt that it will knock the economic recovery off course.”

The FTSE 100 Index fought back from one of its worst sessions in recent years, recovering £46 bn, having dropped more than five per cent on Monday afternoon.

However, with interest rates at a record low and quantative easing already dispatched, there are concerns there would be few options to turn to if the China crisis continues.