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Volatility in stock market shouldn't hurt China, US economy

By Nariman Benravesh (China Daily)
Updated: 2007-03-09 15:03

World stock markets have been pushed down sharply by a convergence of at least four forces recently: 1) a major sell-off in China's overvalued stock market; 2) data releases that have highlighted the weakness of the US economy; 3) signs of stress in US mortgage markets; and 4) ill-timed comments by former Federal Reserve Chairman Alan Greenspan about the possibility of a recession.

While stock markets are likely to suffer through more volatility in the next few months, the fundamentals don't point to an extended bear market. Moreover, this increased volatility will probably only have a small impact (if any) on growth.

China's stock market correction was long overdue, but won't hurt growth.

The nearly 9 percent drop in the Shanghai market on February 27 was relatively small compared with the huge increases in recent months.

During 2006, the Shanghai composite stock index rose 130 percent, compared with only a 16 percent rise for the Dow Jones index. After rising steadily for much of last year, this market has experienced something of a roller coaster in the past two months.

This volatility is largely a function of three factors. First the market is very thin the Chinese government is still the largest stockholder, and only about 10 percent of the shares are traded. Second, 70 percent of the investors are individuals who tend to be less patient and more prone to panic than institutional investors. Finally, the stock turnover in the Shanghai market is three to five times higher than the New York Stock Exchange. This means that the market's volatility is likely to remain high in the near future. Moreover, given the overvaluation of Chinese stocks, further declines in prices seem likely in the coming months.

Despite concerns about the impact of this event, growth in China's economy will probably remain very strong in the coming year. Chinese consumers do not have large equity holdings, and most Chinese companies do not rely on the stock market for financing.

Global Insight continues to believe that China will grow by 10 percent this year, despite the National People's Congress targeting only 8 percent for this year.

While the government is concerned about speculative excesses in the stock market, as well as housing and real estate in Shanghai and Beijing, it is unlikely to do anything that will threaten growth.

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