Since June this year, investors as well as policymakers around the world has been closely watching the Chinese stock market.It is a classic bubble economy that had been growing every year, but now seemed to be on the verge of popping.
Starting on June 12, the Shanghai Composite Index shed about 30% of its market value (at least $3 trillion USD in assets disappeared) during the following four weeks. On July 8, at least 1400 companies filed for a trading halt in the Shanghai Composite Index and the Shenzhen Component Index to try to prevent further losses. On August 24, the Shanghai Composite Index at closing was down 8.49% the same day and had dropped by roughly 40% compared with June.
The China Securities Regulatory Commission updated its statement that the markets were stabilized because the high volatility risk have been eased on September 6. Generally, it said that the government would not intervene officially unless necessary in the future. But in a seemingly contradictory statement, it also mentioned that China Securities Finance Corp, which is the state-owned margins lender, would continue to keep the markets stable by providing financial liquidity.
Until now, the Chinese stock market acted like it was going to grow forever. In what may be the start of a new rocky period for the Chinese economy, how should Taiwan act, with its own economy so heavily tied to China?
Analyzing the current situation
The stabilization of the Chinese stock market resulted mainly from government intervention through different policy tools during the past three months. For example, the authorities used administrative orders to request company executives not to sell their shares and started an investigation into illegal short selling. At the same time, the central bank lowered interest rates aggressively.
From a domestic perspective, investors in the Chinese stock market naturally wanted to cut their losses when the market downturn started, and they began to sell. Of course, there were also speculators who made money by short selling. As more investors trade in the stock market and act simultaneously, the stock market retracted rapidly.
Moreover, as the news media began to report on the stock market and opined on all kinds of possibilities (mostly negative), more people learned about the severity of the situation. Middle-class investors who spent money in the market had their incentive to worry about their investments. For example, they may not afford a home loan when the stock prices go down. Then they followed the same idea, or mania, to get money back as much as possible.
Finally, the role of the government, which was expected to deal with this crisis, had their own incentive to stabilize stock market, encourage investor confidence and eventually keep the GDP growth figures up. There is no denying that the government’s policy solutions are effective; but the same policy solutions may lead to several unintended consequences in the future. For instance, investors have no idea what types of transactions are being banned or even criminalized when the police and regulators launched new limits and investigation. It will harm the Chinese market in the future.
International investors, especially institutions, undoubtedly have their incentive to clear or decrease shares they kept in the Chinese stock market. On one hand, the Chinese economy could continue its decline that started last year. Investors have planned to readjust their asset portfolio in the Chinese markets for a long while. On the other hand, they were placated by the Chinese government’s administrative orders that dealt with this current crisis timely by monitoring potential abuse trading, investigating possible illegal investment activities, and enforcing new and extraordinary restrictions in the stock market. However, international investors will also start to ask this question: is the Chinese government willing to tolerate the turbulence of the selling or short selling that is inherent to the market itself? If not, perhaps it is time to diversify.
In addition, when the Chinese stock markets crashed, where does that leave Taiwan? According to economic data, Taiwan’s economy, especially for the exports to China that were about 30% of Taiwan yearly GDP, is basically dependent on China’s economy and could be a risky signal for investors. No wonder investors sold their shares on the TWSE, which after August 24. Taiwan’s government decided to invest its national stabilization fund into Taiwan’s stock market if needed in order to prevent any major Taiwan stock market or economic crisis from this Chinese stock market crash.
Due to the interconnected nature of international financial markets, no country can stand completely alone from the negative external shocks coming from other countries. The key point is how Taiwan should act. The Chinese stock market crisis is just one of the examples of how Taiwan’s economic dependence on China led to TWSE falling. Nobody can deny that China’s market is one of the most important global markets. The question here is how to diversify in the smartest way possible.
Around 40% of Taiwan exports to China are ITC Electronic products, a percentage that is higher than South Korea (under 25%) and Singapore (under 20%). At the same time, China’s “red” supply chain has grown bigger and faster recently, especially in related materials, machinery parts and ITC. Taiwan companies, especially China-based Taiwanese businesses, tend to lower their costs as much as possible by purchasing in bulk from China local suppliers in order to compete with local businesses and survive in the global market. Moreover, in order to diversify product lines and deal with increasing labor costs in China, Taiwan business aimed to speed up robot development, especially robotics engineering. But how much will these measures help? According to a recent news report, companies in the LED, TFT-LCD panel and photovoltaic industries had laid off some employees due to the negative view of Taiwan economic outlook.
Taiwan still has some hope. Based on TIER’s August survey, here are some perspectives about industries that are expected to improve over the next six months. In manufacturing, this includes three ITC related industries (Electrical Appliances and Housewares, Electrical Machinery, Communications Equipment and Apparatus), supplies manufacturing and repairing, precision instruments, bicycles parts and bicycles, and education and entertainment articles manufacturing. In services there are insurance, restaurants and hotels. Note, there are very few ITC industries in this survey. In other words, Taiwan’s ITC industries had most likely been too dependent on the China “red” supply chain, as evidenced by the effects of the Chinese stock market crash.
Every developing country has its own incentive to support its infant industries and develop local companies. It is not enough to simply move production lines and factories from one low cost country to another low cost country, for instance from China to ASEAN countries. In the long-term, there is no doubt that we will still encounter the same situation with outdated industries competing simply on cost and labor. Moving from one country to another in order to use lower cost is never a permanent solution. Taiwan’s investors need prepare new investment strategies.
Here are three suggestions. First, invest more in non-ITC industries (i.e, precious instruments) in advanced countries to upgrade our technology. Second, do not concentrate only on commodity production and sale, especially in downstream industries. Taiwan should focus on expanding and creating midstream of non-ITC industries market share (i.e, machinery equipments and parts) as much as possible, no matter in developing or advanced countries. Third, and most importantly, invest in new and upcoming enterprises within Taiwan. Only by developing its own technology, especially for upstream industries (i.e, electrical transportation vehicle), will Taiwan find the next source of economic growth and power.
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