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Current Situation
August 2015 has been a horrible month for the Chinese economy. While stocks continued to tumble, regulators fumbled by ordering an inconsequential 3% devaluation; except that this became the cue for markets to conclude that something was really wrong with the economy, further pulling stock values down. At this point it would be wise to remind ourselves that China does not really have a market economy; it has the Communist Party. Hence there is every possibility that the economy may recover on massive State mandated spending. In fact news reports circulating last month indicated that President Xi Jinping had 'ordered' Chinese authorities to ensure that the markets far from dropping must actually go up!
Analyst's take
"The stock market sell-off is not the problem?.?.?.?the problem - not a huge one, but a problem nonetheless - is the Chinese economy itself;"says Chinese economist David Daokui Lee.
Yet, market volatility does matter too. Agood indicator would be the $200 billion the Chinese have splurged in futilely trying to prop up the markets. Equally important is the fact that China's foreign reserves have dipped by $315 billion. The continuing fall in markets is a pointer to the lack of confidence in the economy. In the past two decades, the Chinese economy has clocked around 10% p.a., pushing per capita income in PPP terms to 25% of the U.S. income.This terrific achievement can be seen and felt on the ground.
"Without reforms, growth would gradually fall to around 5 per cent with steeply increasing debt," according to the IMF. But such a path would be unsustainable, not least because debts are already at such a high level. Thus "total social financing" - a broad credit measure - jumped from 120 per cent of GDP in 2008 to 193 per cent in 2014. The government can manage this overhang. But it must not let the build-up restart. The credit-dependent part of investment has to shrink. (Financial Times September 1, 2015)
The consulting firm IHS Global Insight estimates that debt relative to China's output will reach 254 percent in 2015 nearly double the level of 2008. If borrowers start defaulting on these loans, the whole economy would be in trouble. "The size of debt only accumulates," said Grace Wu, a senior director at the rating agency Fitch in Hong Kong. "That doesn't help with the underlying economy. It doesn't help create jobs."
More worries
Another worry is the woeful state of China's national economic statistics. Virtually no one believes the figures put out by the government. Measured by electricity consumed, freight shipments, increase (or decrease) in exports, and other such indicators, most economists agree that the China's current growth rate would be only about half of the 7% growth put out by official statistics. This has left many market players, who lack clean data and clear signals,in the dark. This has led many investors to exit the market, at least partially, in an effort to protect their investments. "Critical to China's success is moving forward with market-oriented reforms, while at the same time, carefully communicating policy intentions and actions to financial markets," says a senior US Treasury official. (Wall street Journal, 1st September, 2015.
The Purchasing Managers Index, (PMI) a key index of economic activity, declined from 50 in July to 49.7 in August, according to official statistics. A reading above 50 indicates expansion in manufacturing activity while a reading below points to a contraction.
The slowdown has affected wide sectors of the economy. Many factories which were set up in the boom years were financed by soft loans from government banks. These factories now have little or no orders and no business. Yet they continue to pay token salaries while a few have stopped even this. These empty factories will weigh heavily on China's recovery. Once the economy starts to reboot, production from these factories will first have to be absorbed before new ones need be built, affecting investment growth. Since investment growth is the main driver for China's overall growth, government banks continue to support these companies by restructuring loans, giving new loans and other financial aid. Further,the government's hands are forced in yet another way. The Communist Party government fears that higher unemployment would trigger social unrest. To boost the economy China cut interest rates by 25 basis points on August 25, the fifth reduction in the last ten months.
Regional impact
"Global investors have now come to realize that China's travails are beginning to affect everyone," says Frederic Neumann, co-head of Asian economic research at HSBC in Hong Kong. (New York Times, 28th August, 2015)
Australia which exports a lot of commodities to China is already feeling the pinch. It is now staring at a recession for the first time in 24 years. Analysts expect the Australian economy to decline in the secondquarter. Similarly, South Korean exports plunged a huge 14.7% in August compared to the same period a year ago. The biggest reason for the slowdown was the poor demand from China, South Korea's largest trading partner. This is also the first concrete evidence of slowdown in regional trade since China's surprise currency devaluation in August.
The Japanese economy too is on a downward spiral. It decreased in the second quarter and is again expected to tumble further in the third quarter. Exports to China are down by 10.8% in the first half of the year and are expected to remain muted in the second half as well, pulled down by lagging shipments of electronic goods and equipment to make electronic goods. Malaysia and Vietnam saw manufacturing declines in August. The Yuan's depreciation seems to have cut into the export markets of these countries. (WSJ 1September 1, 2015).
The bottom line
All countries go through the economic cycles of boom and bust. What has caused concern in the case of China is that, its data is unreliable and thus markets are unable to react in a measured manner. Economic growth in much of the rest of the world still remains fragile. The hope in recent years has been that China would help pull the world out of the mess left behind by the Financial Crisis. Evidence that China might not be able to do so is hugely disappointing. It is perhaps this disappointment that is at the center of recent global market gyrations.
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