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Why China’s stock market panic is overdone

September 29, 2015, 11:00 PM UTC
An investor looks at screens showing stock market movements at a securities company in Beijing on July 14, 2015. Hundreds of firms were expected to resume trading again on July 14, adding to the more than 400 that returned July 13, after they were suspended over the past few weeks to prevent a market meltdown. Authorities intervened after the Shanghai index plunged 30 percent in three weeks, wiping trillions of dollars from market capitalisations, spreading contagion in regional markets and raising fears over the potential impact to the real economy. AFP PHOTO / GREG BAKER (Photo credit should read GREG BAKER/AFP/Getty Images)
Photograph by Greg Baker – Getty Images

China is slowing down. This has caused serious concern for many, as investors across the U.S. seem easily spooked by any news regarding the topic. Just the other week, in her press conference explaining the decision to leave the targeted federal funds rate unchanged, Fed Chief Janet Yellen invoked China 16 times, directly or indirectly. She expressed fears that China’s slowing economy could cause a ripple effect and drag down U.S. growth. Many pessimists even declared this to be the “end of China” story.

Chinese GDP is no longer growing at about 10% per year as it has in the last decade. Today, growth stands around 7%. That’s certainly slower, but we need to those figures into perspective. In 2003, Jim O’Neill, the father of “BRIC,” and his Goldman Sachs (GS) team predicted that by 2015, China’s real GDP growth rate would only be 5.2%, and would drop below 5% by 2017. The slowdown of the Chinese economy was not indeed unexpected. No country can grow at 10% forever. Diminishing returns will kick in and the richer the country is, the slower the growth will be. Judging by O’Neill’s prediction, China is currently doing quite well.

More: China’s stock market is about to tank — again

Ten years ago when China was growing at over 10% a year, its GDP was about $2.5 trillion. Every year, China added around $250 billion to its economy, equivalent to adding the GDP of Louisiana, or the Philippines. With GDP growth today at about 7% (or over $10 trillion), China’s economy is essentially creating a new state the size of Pennsylvania every year. This is more than decent.

It is true that China’s stock market has dropped 40% from its peak, but that’s less an indication of China’s slowdown than a correction from an irrationally engineered bubble. When analysts commented on China’s stock market decline, many ignored when it rose by 150% within the last year. Even with the recent stock market turmoil, China’s stock market today is still up by 50% from last year. For many reasons, China’s equity market bears little relationship to its economic growth.

During the last 20 years when China was experiencing rapid growth, its stock market barely budged barring occasional irrational exuberance and correction. The correction of its stock market this year is not necessarily an indication of some serious problems in China’s economy. Its stock market will not drag down its GDP growth rate, given that less than 15% of Chinese household financial assets are in the stock market. What’s more, margin loans are less than 2% of total bank assets.

More: Why China’s market crash won’t mean global chaos

Some suggest that the slowdown will create a serious debt crisis in China, causing mayhem in the financial world and throw China into depression. The total debt, including corporate and government, is about 180% of GDP, according to the Chinese government statistics. Some argue that by including other governmental obligations, China’s comprehensive debt-to-GDP ratio could reach 250%. This is indeed alarming until one looks at the asset side. It is estimated that China has, after 30 years of growth, accumulated an asset about 10 times of its GDP. Reforms on the local government financing platform and the shadow banking system, which is estimated to be around 25% to 50% of GDP, are already under way. The risk is reducing. With a national savings rate close to 50% of GDP, a huge asset size and still limited international capital mobility, those who want to profit from China’s doomsday situation will have to wait for a long time.

There will be no shortage of pessimists going forward, but China will again disappoint them. Contrary to what these people say, the China story is far from over. It’s just the beginning of a new chapter of this great story.

Baizhu Chen is a professor at the Marshall School of Business at the University of Southern California. Imaad Zuberi is vice chairman of Avenue Ventures.