While a financial crisis is identified as the major downside risk for China—and even for the global economy—China’s recent stock market correction is far from shaking the country’s financial system, or its overall economic trajectory. However, the equity slump will have indirect downside effects on consumer and business confidence, the real economy in China and commodities prices worldwide.

China’s economy is slowing, not crashing

GDP growth met expectations of 7.0 percent YOY in the first half of 2015. However, in the second half of 2015, the Chinese economy will see soft consumption, as well as weaker industrial production and exports. FSG’s base-case scenario for China calls for slower yet steady growth, as the government shifts the country’s investment-led economy to a consumption-led model; 92 percent of FSG’s multinational clients believe that this base case will prevail.

We have lowered China’s 2015 GDP growth forecast to 6.9 percent YOY with the slightly lower expectation on consumption and investment growth.

Financial disruption is China’s biggest risk

A potential financial market disruption remains the biggest risk to China’s macroeconomic environment. However, it is important to differentiate a stock market correction with China’s financial system breakdown mainly because China’s major banks and financial institutions are not at the center of the storm in an equity market slide, and the stock market only accounts for a small fraction of China’s overall financial assets.

What’s more, FSG’s estimates suggest that 70 to 80 percent of China’s stock market capitalization is made up of state-owned companies, raising the stakes for the government—and the government’s ability to fend off additional crises were they to occur at once—if prices fall.

Equity market disruptions will weaken confidence

Only about 15 percent of China’s household wealth is invested in the equity market. However, it is unclear exactly which 15 percent of wealth this included, since many lower-income households are believed to have entered equity markets just before the crash. On aggregate, it is FSG’s view that falling share prices will not impose a significant impact on consumption.

However, depreciated investment portfolios are likely to prevent retail investors from making big-ticket purchases in the real economy. The government has been reducing taxes for imported goods like skincare and shoes, trying to spark domestic consumption, but the overall demand is still sluggish.

Interest rates reductions are now more likely

Dampened consumer and financial markets confidence will put downward pressure on inflation within China. Monetary easing in China has been gradual so far, particularly compared to the large quantitative easing scheme in the United States. However, low inflation leaves lots of room for interest rates and reserve requirement ratios for commercial banks to be further reduced. We have already seen some positive results in the property market, as the government relaxes property purchasing constraints and cuts benchmark interest rates.

Commodities prices will continue to decline

As the government shifts the economy from an investment-led model to a consumption-led model, and the Chinese economy experiences weakened industrial production, FSG anticipates less demand from Chinese producers for commodities worldwide. The indirect impact of China’s recent equity market activity on consumer and investor confidence will further dampen expectations for Chinese growth over the long term, holding commodities prices even lower.

Global economic growth will face headwinds as a result

China’s economic slowdown will also have an important impact on regions outside of China. Expectations that demand for commodities will remain low means that export revenue for commodities exporters will be weaker than anticipated. Lower revenue in turn puts downward pressure on those countries’ governments to cut spending on social services, infrastructure and other investment that stabilizes and diversifies economies in the long term.

Companies—even those with major portfolios outside of Asia Pacific—should monitor China’s financial markets and broader economic growth developments. China’s economic health is important for economies all over the world. The next six months are likely to be volatile for China as the government attempts to soothe fears over its ability to keep the economy on track. Much is at stake, both within and outside of China, on its ability to do so.

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