Stock market volatility is a poor predictor of the state of China's economy

Shang-Jin Wei cautions against dire forecasts for China's economy based on turbulence in the stock market, which does not reflect the fundamentals

PUBLISHED : Monday, 07 September, 2015, 4:07pm
UPDATED : Monday, 07 September, 2015, 4:07pm

To hear some pundits tell it, China's economic miracle - one that lifted 300 million people out of poverty and shifted the world's geopolitical centre of gravity - is coming to an end. The volatile stock market and the renminbi's depreciation are signs of imminent economic collapse, according to this view, as risky investments and high levels of government debt put the brakes on growth.

Fortunately, there is little reason to believe such dire predictions, or that the market gyrations represent anything more than short-term volatility. After all, equity-price movements are a poor predictor of the real economy's performance.

Indeed, when Chinese gross domestic product was growing strongly from 2010-2013, stock prices were falling. More recently, when stock prices began soaring early this year, the economy's slowdown had already begun.

The volatility in equity prices has more to do with the peculiarities of China's stock markets than with the country's economic fundamentals

China's growth has slowed largely as a result of changes in its fundamentals: less favourable demographics, a shift in emphasis from exports and public investment to the service sector and domestic consumption, and lower demand from advanced economies. But China's past success also contributed to this slowdown, in the form of higher wages.

Additional signs of weakness, including soft data on exports and investment, emerged in the first half of this year. But other important indicators - like retail sales and housing - show upticks. And, perhaps most important, the country's labour market remains healthy, creating some 7.2 million new urban jobs in the first half of this year. Meanwhile, wage growth remains strong.

The volatility in equity prices has more to do with the peculiarities of China's stock markets than with the country's economic fundamentals. In more developed economies, such as the US and Europe, many institutional investors help stabilise markets. By contrast, the Chinese markets are dominated by retail investors, who are more likely to pursue short-term gains, exacerbating volatility.

Whether China's economy can continue to grow rapidly will depend far more on its ability to reform than on how its stock markets perform. This means it will need to overhaul state-owned firms and the financial sector so resources can flow to the most productive investment projects. Reforms that increase the flexibility of the labour market are also in order.

As long as China continues to pursue pro-market reforms, it will remain the largest single-country contributor to global GDP growth over the medium term - unperturbed by stock-market volatility. If reforms stall, falling stock prices are likely to be the least of China's worries.

Shang-Jin Wei is chief economist at the Asian Development Bank. Copyright: Project Syndicate