Investors in Chinese equity know from the past they have put their money on a roller-coaster. But the recent drop is very rough, and – says financial analyst Sara Hsu to the ChinaUSFocus, the drop is worse because much stock has been used as collateral for loans.
However, there is fear that too many of the listed company shares have been pledged as collateral for loans. The total amount is equal to 10-12% of the A-share market cap, according to Sean Darby, chief global equity strategist at Jefferies. This is starting to create a downward spiral as margin calls (demands for additional securities to cover losses) and forced liquidations are carried out and threaten to bring contagion to the real economy, which is already under pressure from dampened demand.
At the moment, it appears that risk is under control, but just barely. If the stock market continues to melt down, government intervention may be required to stem sharp price declines and reduce the impact on the rest of the economy due to the knock-on effects of margin calls. All of this only serves to compound the lack of funding and bearish sentiment that are worsening the slowdown.
Government intervention is necessary but certainly not desirable, as it moves China’s economy even further away from the market-oriented system it has been striving for. At this point, the prospects of reform appear dim, as the nation attempts to curb assaults on its very economic viability. A lot must happen in order to improve the country’s prospects: calling off the trade war, removing bad debt, and stimulating consumption and investment will all have to occur before China gets back on its feet and the stock market appears healthy once again.
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