Fears over China's market crash are overblown

Has China's economic bubble burst?
Has China's economic bubble burst?

China's stock market is a mess.

The Shanghai Composite Index lost 30% of its value over a three-week period starting in mid-June. Then, after a modest rebound, it plummeted again this week, posting its largest single-day loss in nearly a decade.

 Kent Kedl Control Risks
Kent D. Kedl

The volatility has caused some considerable hand-wringing in many other economies over fears that China's woes could spur a global sell-off.

That's not likely to happen. The stock market in China is notably different from other major trading floors. It is highly speculative and the bets placed by the retail investors who play there are unlikely to reflect broader economic and corporate trends; particularly when compared to the institutional investors who predominate exchanges in other major economies.

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Moreover, companies have relatively little exposure to market fluctuations in China. Only about 5% of private sector fundraising in China comes from the stock market itself; this gives businesses a layer of insulation from market volatility.

In other words, China's stock market does not reflect the country's economic health in the same way that markets do in other countries. If exchanges in New York or London or Tokyo were to suffer a 30% decline, fears of a depression might be warranted. But in China, such volatility does not necessarily portend an economic crisis.

There is no denying that China's economy is slowing, and that broader trend is certainly troubling. But the stock market's fluctuations are a very minor factor in the country's economy, and offer no real insight into the China's economic direction.

Related: China has a major bubble problem

Possible political crisis: The greatest concern over China's market is not that is will create an economic crisis, but that it will create a political crisis for China's leaders.

For most of the last two years, party leaders in China have encouraged investment in the stock market -- in part to steer Chinese investors away from real estate, where fears of a bubble also exist. Chinese citizens have seen social media campaigns and billboards touting the safety of the stock market and emphasizing its growth as key element of the country's modernization.

So when that very same market drops precipitously -- and when the government appears unable to intervene and stop the slide -- it creates a credibility problem for leadership. Estimates suggest only about 7% of China's urban population owns stock, so this loss of credibility seems unlikely to be the kind of crisis that brings demonstrators into the streets. But it is nevertheless a real problem for Xi Jinping and others atop the Communist Party.

Xi has spent the last two years establishing himself as a strong leader and has demonstrated considerable power in other areas -- particularly when it comes to rooting out corruption within business and government alike.

While his actions have met with general public approval in China, they have also ruffled feathers in some circles. His seeming powerlessness to grab the reins of the stock market damage the image he has crafted for himself, and create greater political uncertainty within China in the short term.

Related: China's market meddling could do more harm than good

Bad timing for China: The timing of the market's current slide is particularly poor. Party leaders are already at work drafting the country's next five-year plan, which, based on Xi's track record, is likely to contain important reforms that could boost stability in China. But a loss of face over a volatile stock market could cost Xi the opportunity to make these changes, allowing more fundamental economic problems to persist.

It is a typical Chinese puzzle: the temptation is to look at daily movements of the China stock market as having immediate impact; rather, we should be looking at a 3 to 5 year horizon for how China's sliding stocks will impact the Chinese leaders' ability to execute fundamental reform that will, eventually, stabilize the stock market.

Kent D. Kedl, based in Shanghai, is senior managing director for China and North Asia at Control Risks, a global risk consultancy.

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