China Economic Spotlight : What negative wealth effect?

The Shanghai Composite Index has fallen 27% since 12 June 2015, a sharp drop versus the 117% jump over the previous eight months. These dramatic swings have raised concerns about a possible negative impact on the economy. In this note we look at the main channels through which equity market volatility can affect the real economy. First, our estimates suggest that the stock market wealth effect has less impact on consumption than many think. Consumption growth in China is largely driven by income growth rather than changes in wealth and Chinese households still park most of their wealth in cash and deposits. Second, the recent IPO rush notwithstanding, total equity financing year to date amounted to RMB289bn, less than 5% of total social financing over the same period. Third, although margin financing on the equity market has risen rapidly, the trend has started to reverse over the past few weeks. The latest measures to stabilise the stock market, unveiled over the weekend, will help to cushion the impact on sentiment and limit the risk of financial contagion.