Made in China: Is another recession on the way?

25 August 2015 -

A mass sell-off of Chinese stocks has sparked fears of another global financial crisis, but what caused the slump; and what does it mean for businesses in the UK?

Jermaine Haughton

A shocking 8.5% drop in the Shanghai Composite Index rocked the globe yesterday morning, as the world’s second largest economy experienced its worst slump in eight years.

This led to the hashtag #BlackMonday trending on Twitter across the globe as it reignited memories of the 1987 stock market crash and the collapse that spawned the great depression of the 1930s.

The mass sell-off of Chinese stocks occurred just one day after a government-approved move to allow the state pension fund to invest in the stock market in an attempt to prevent the market’s bubble from bursting.

Here are the six key insights you need to know about the Chinese financial crisis.

CHINA’S ECONOMY IS STRUGGLING

Despite the Chinese government reporting better-than-expected 7% growth in the second quarter, scepticism remains from experts regarding the validity of such data considering clear signs China is not performing as strongly as in the past.

According to Bloomberg, China’s nominal GDP growth is running 2% lower than last year, a far cry from the double-digit growth last seen in 2013. Performance in key indicators such as manufacturing and construction also show China’s struggle to handle a bloated economy, where its GDP growth has become outstripped by mounting debts.

The preliminary Caixin/Markit China Manufacturing Purchasing Managers' Index (PMI), released last Friday, showed the country’s factory sector shrank at its fastest rate in more than six years in August. Recording a 47.1 score, it is importantly the sixth straight reading below the 50-point level that separates growth in activity from contraction on a monthly basis.

THE SHANGHAI BUBBLE HAS BURST

Investor concerns over the sluggish Chinese economy have been exacerbated by the inflated prices of domestic stock. The relaxation of China’s borrowing policy has led to a diverse pool of individual speculators – from grandmas to college kids – frequently trading stocks, effectively pumping up their value above their actual worth and creating a market bubble.

Each quarter stories emerged of an amateur trader who made a small fortune trading stocks, and the hype contributed to China’s shares soaring 150% in the 12 months to mid-June.

Patrick Chovanec, managing director at Silvercrest Asset Management, said last month: “China's stock market had become detached from the reality of China's own economy, and appallingly overvalued.”

CHINESE GOVERNMENT LIKELY TO INTERVENE

In what is still often regarded as a “communist” nation, it is rare for China’s officials to publically shine too bright a light on negative events in the country. With growing pressure from the Chinese people and investors on Beijing officials to halt the chaos, experts expect the government to implement measures to calm the concerns of investors and restore international confidence in its sluggish economy.

Even before the stock market crash, China's government has already moved to support share prices by surprisingly devaluing its yuan currency last month and having brokerages commit to buy billions worth of stocks.

But within a regime that is notoriously secretive, such public gestures have so far only helped to amplify investor doubts, with every action perceived as a further sign of quite how worried officials are about the slide in shares and the wider economic troubles in the country.

FTSE CAUGHT THE CHINESE COLD

Mirroring the depth of the recession in March 2009, some £74 billion was wiped off the value of the FTSE 100 yesterday following the crisis in Shanghai, with the Dow Jones Industrial Average following suit as it fell by a record of more than 1,000 points at one stage.

With China now accounting for 15% of the world economy, its domestic issues soon became an international crisis, with the country investing billions of pounds annually in the UK alone. Over the past four months – as the murmurs of disorder of the Chinese market grew - the FTSE lost 17% of its value, or £308.3bn.

David Madden, a market analyst at City trading firm IG, said: ‘The panic that started in China is highly contagious. European stock markets have been crushed by the fear that China is about to crumble. The sea of red on trading screens is reminiscent of the credit crisis. Dealers don’t know what to do with themselves because the market moves are so enormous and erratic.”

However, morning trading on the FTSE has seen the index jump 2% on Tuesday morning, with other European markets following suit.

BOOST TO UK IMPORTS AND EXPORTS

Following successive falls in crude oil and copper prices over the past year, Black Monday was particularly damaging to mining stocks, as reflected by the value of multinational giant Glencore falling by as much as 12% yesterday.

However, a combination of low oil and commodity prices and cheaper Chinese imports may turn out to be a positive for many British businesses, at least in the short-term, reducing costs and increasing profits.

ANOTHER UK RECESSION?

With the Chinese government likely to be consumed with turning around its tumbling stock market and stabilising domestic growth, its ventures abroad are set to take a hit.

Last year, law firm Pinsent Masons predicted China would invest more than £100bn in infrastructure projects in the UK by 2025. Although still too early to tell, a significant and prolonged slump in Chinese investment during this period would likely threaten jobs, reduce property prices and stunt the Conservative-led government’s growth plans.

An article in The Telegraph reported that the UK has been one of the leading nations reaping the rewards of growing Chinese investment and a decline its economy may lead to a tightening of the purse strings.

Some experts, however, believe it is unlikely the UK economy will be dragged into another crisis due to problems in China.

Julian Jessop, the chief global economist at consultancy firm Capital Economics, said: “The current panic is essentially ‘made in China’. The recent data from other major economies, including the US, Eurozone and Japan, has generally been good.

“Aside from the bad news from China, there is very little to support fears of a major global downturn.”