By Dr Rakesh Gupta, Griffith Business School
The average Australian has approximately $113,000 invested in managed funds out of which $84,000 is invested in superannuation. The bulk of this is invested in the stock market.
As such Australians are most sensitive to the volatility in the stock markets. When the global markets tumbled this week, it sent a shock wave through the Australian market.
Everybody is scared and talking about the decline in global markets especially China.
The sharp decline in the market is of concern but we shouldn’t be alarmed. It is a correction in asset prices and investors should stay calm and focus on their longer term investment objectives rather than current shock.
China currently is the second largest economy in the world and has been growing at a fast pace over the past three decades. This growth in China was initially led by China’s exports to the world owing to low labour costs.
With the Global Financial Crisis there was a collapse in the global economic environment and demand for Chinese manufacturing declined. The Chinese government increased its spending on infrastructure development to keep pace with economic growth in China.
This infrastructure spending may have been important and required for future development of China. However, some of this infrastructure development was meant for continuing the economic growth (or GDP growth as is commonly measured). This was done in the belief that soon the GFC will be over and things will get back to normal.
Unreasonable
However, the GFC was protracted and severe resulting in a long period of infrastructure spending some of which was in unproductive assets. This implicit assumption of continuing infrastructure spending was an unreasonable assumption and was to be proven false. Once China pulled back on the infrastructure spending a normal growth rate which is more modest is causing panic around the world.
Unprecedented growth rate in China is appealing to all around the world. However, this higher growth is also important for the Chinese policy makers. Higher growth rate in China has allowed people in China to ignore any weaknesses and frustration; such as high level of corruption, high unemployment rate among educated youth (unemployment among recent university graduates ranges between 15% and 30%), increasing inequality in society and changes in social values.
In light of unprecedented growth all these weaknesses were ignored as everyone was enjoying the benefits of economic growth. And that may have been the reason for policy makers to try and maintain exceptionally high growth rates at any cost. I had been concerned about the belief that China will continue to grow at this rate even in 2009.
Recently President Xi’s government has been propping up the stock market and the Chinese public and the world believed that China was able to support the market for an indefinite period of time. However, despite all the support provided China’s stock market has declined and continue to decline.
We need to understand that regulators and government in China cannot continue to support Chinese market indefinitely. This correction was inevitable after a long period of rise in asset prices. Currently Shanghai A share index is still above 2014 levels and not significantly below the lowest point of 2015.
We also need to remember that China’s stock market is dominated by individual investors and generally considered as a speculative market. As such price movements may be more influenced by sentiments rather than fundamentals.
Finally, everybody is concerned about the decline across the world. However, this decline — though significant – is a single-day decline. Looking at longer term trends all markets (excluding China which rose exceptionally during 2015) have had a positive trend except for the past week and a half. Despite the significant drop, price levels are generally above 2009 levels in USA, UK, Australia and Germany.
An important issue policy makers in Australia need to consider is its reliance on China in terms of trade. Australia’s bilateral trade with China is more than 28% and continues to rise whereas with other major trading partners such as USA and Japan it is 6.7% and 13% respectively, and is declining as reported by Paramati, Gupta and Roca in a recently published paper in Applied Economics.
Australia’s bilateral trade with another rising economy such as India is at 2% and has declined over recent past. China’s GDP in 2014 was $10360 billion USD against India’s GDP of $2066. Australian bilateral trade with China is almost 14 times that of India, whereas China’s GDP is five times that of India.
Australia needs to decouple its economy from China and diversify its economic linkages with other economies and diversify its economic exposure to other global economic risk factors rather than being exposed to only China.
Dr Rakesh Gupta researches share markets and investments at Griffith Business School.