Slide in Chinese stock markets sparks fears of fresh falls for Western equities

Analysts say correction is not a reflection of China's economic prospects

Chinese equities briefly tipped into bear-market territory yesterday, with the Shanghai Composite index falling as much as 5.1 per cent – down 20 per cent since this month's peak – before closing 4.3 per cent lower.

The closely correlated CSI 300 index was down nearly 5 per cent, sparking worry on the FTSE 100 in London and the Dow Jones Industrial Average in New York, both of which have enjoyed a strong summer, but now show signs of buckling under as we near the first anniversary of Lehman Brothers' demise.

Given the backdrop, nervous traders expressed concerns about the signal from Asia, wondering if the Chinese stock market was ahead of the curve. So, can it see through the recent raft of economic green shoots that have emboldened western investors? And will it bring out the bears in the City and on Wall Street, depressing leading stocks a year after they suffered their worst convulsions in living memory?

Not necessarily, analysts say. Notwithstanding the weakness in domestic equities, forecasters predict strong growth in the wider Chinese economy, a pull-back which is likely to bear down on world markets.

Market watchers said that instead of presaging a slow-down, the declines reflect a correction following heady gains in recent months. Both the Shanghai Composite and the CSI rose in response to Beijing's mammoth fiscal stimulus programme and centrally orchestrated surge in bank lending. Some of this cash – Chinese banks granted more than $1 trillion in loans to businesses and individuals in the first half of the year – is believed to have sloshed into the financial markets, driving share prices higher.

Khiem Do, a senior fund manager at Baring Asset Management, said the People's Bank of China, the Chinese central bank, now appears to be orchestrating a turnaround, discouraging commercial banks from lending where the money may end up in parts of the economy that are deemed speculative, while recommending that they fund more productive activity. Infrastructure projects, for example, would fall in the latter category, while the financial markets would be covered by the former.

"This projected deceleration in the money being used for speculation has, we think, motivated the profit-taking and caused the correction in the Chinese A-share market. From an economic viewpoint, our analysis continues to suggest that the economy in China remains very strong."

Western stock markets have also been strong in recent months. But their gains pale in comparison with those notched up by their Chinese cousins. The Shanghai index, for instance, has climbed by more than 50 per cent so far this year, while the CSI is more than 65 per higher since the beginning of January. The FTSE 100, on the other hand, is around 5.5 per cent ahead of where it began the year.

Likewise, although Western indices may suffer further losses in the coming weeks, they are not expected to decline by as much as those in China. Shanghai, for example, is down nearly 20 per cent since the beginning of this month. The CSI 300 is down 20.4 per cent. But the FTSE 100 is, in fact, broadly unchanged.

Moreover, the declines are likely to be caused by local indicators. Monday's losses, for example, were blamed on weak retail sales and consumer confidence figures out of the United States.