Stock Market Crash: Chinese Economic Collapse Feared After Stocks Plunge 7.4%

China Stock MarketChinese stock markets crashed on Friday, June 26th, posting their biggest daily decline in seven years.

The Shanghai Composite and the Shenzhen Composite tumbled 7.4% and 8.2%, respectively. More than two thousand stocks fell 10%, the maximum daily loss allowed by regulators.

The ChiNext Board also experienced the largest daily loss since its inception. The ChiNext board is a NASDAQ-style board of the Shenzhen Stock Exchange focusing on innovative and fast-growing companies. On Friday, nearly 400 stocks fell on the ChiNext Board, with the ChiNext Index plunging 8.9%. Over the past three weeks, the index lost more than 27%.

One factor that drove Friday’s crash was margin calls. Chinese regulators have tightened the rules on margin lending, but margin debt was still huge in the Chinese stock market. Once stock prices dropped, investors received margin calls from brokerages, and many had to close their positions to cover margin calls. This magnified the downward pressure on the Chinese stock market.

Xiaojun Zhang, spokesman for the China Securities Regulatory Commission, said that Friday’s drop was an adjustment to the rapid growth in the market previously, and was a result of market forces. At the same time, he mentioned the effect of deleveraging and mid-year liquidity issues. (Source: Sina, June 26, 2015.)

Mid-year is a time that a lot of Chinese financial institutions require payments from borrowers. Some of those borrowers are in the stock market, and some need to sell their shares to repay the banks. This creates downward pressure on the stock market that is often seen in mid years. But never has the decline been so steep.

For investors, the question now is whether today’s stock market crash could spur a Chinese economic crisis. Investors were expecting actions from the People’s Bank of China (PBOC), the nation’s central bank, in response to last week’s turmoil. The Shanghai Composite tumbled more than 13% last week, and the hope was that PBOC would lower interest rates this week. But that did not happen. However, analysts expect that in response to Friday’s record plunge, the central bank will lower interest rates and reserve requirement in the upcoming weeks.

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