As the Chinese stock market went plummeting in a 23% fall during the first week of trading in January of this year, doubts have been raised about the state of the Chinese economy and what broader implications a general slowdown might have. After giving a brief overview of the current situation, Scandic Sourcing talks to renowned financial journalist Roger Aitken to get a grip on where the Chinese economy is heading.
Stock market chaos
The Shanghai composite index is down almost 40% since its June 2014 high, and growth is continuing to decline especially in the manufacturing sector. Beijing’s unpredictable response to the issues are sometimes contributing factors to the fall such as the use of circuit breakers which shut down trading once the market had fallen below 5%. This new practice caused even more panic and was quickly suspended.
The January crash came after a weak year of 2015 that saw the lowest growth numbers in a quarter century, halting at 6.8% after a slow last quarter with especially poor growth in the industrial sector. This ties in to the broader story of China’s ambition to transition from a manufacturing driven economy to a consumption driven one. Thus, large parts of the Chinese service sector is growing, while traditional industrial sectors continue to decline.
What exactly is 'Smurfing'?
The shaky economy has also triggered a mass exodus of capital last year which continues in 2016 as well. Chinese citizens are not entirely free to take capital out of the country, though many are trying to do so illegally. Currently, the cap is set to $50 000/year. This is overcome by a procedure known as “Smurfing”, where wealthy Chinese employ the services of relatives to help them get money out of China. One woman, using than 140 relatives and friends was able to convert $7 million from renminbi into dollars. Over the last year, companies and individuals moved nearly $1 trillion from China which has continued to lessen confidence in the Chinese economy.
The Chinese central bank is fighting the pressure by selling dollars from its currency reserves and purchasing renminbi. China's foreign currency reserves is taking a toll, sinking by $108 billion in December and an additional $99 billion in January, to $3.23 trillion down from $4 trillion a year and a half ago.
To straighten out where things are headed and what implications China’s economic turmoil might have for the world at large, Scandic Sourcing talks to financial journalist Roger Aitken, former Financial Times staff writer in London who writes on markets, exchanges, trading and IT. Currently he contributes to Forbes and other titles.
Image credits: Jason Spoor, White Fox Studios.
If China’s economy keeps stumbling, is there a risk for a domino effect a causing global recession?
"There has been a slowdown in China that's been going on for five years now and the realization is starting to dawn in certain quarters that there is a real risk of a Chinese credit crisis.
Clearly, there could be risk of a domino effect causing a global recession. And, perhaps eyebrows should be raised over China’s debt-to-GDP ratio that recently stood at around 228% on an absolute level - both public and private debt - according to sources including the World Bank, central banks and Oxford Economics.
Put in context, South Korea ranked in second place with 222% debt-to-GDP, Taiwan was third (174%), Malaysia fourth (169%), Thailand in fifth (154%) and Brazil in sixth spot (129%). And capital outflows from China have been rising too.
But the more important test is the five-year percentage change in the same debt-to-GDP. This is due to the fact that a rapid increase in leverage is an important indicator of future stress in the financial system. For China this stands at 47% and heads Thailand and Brazil in joint second place on 27%.
Economists and policy makers have agreed that China should rebalance its economy, with less dependence on investment and export growth and greater importance for consumer spending. But this will take time and along the way there will no doubt be a few shocks to the global economy and world stock markets going forward.
The industrial sectors with the largest excess capacity were rarely addressed by the Chinese authorities, as local governments had major economic interests in those sectors. Overcapacity became even more significant in industries such as steel and aluminium, and in parts of the housing market.
It’s far too premature to predict the decline of China’s manufacturing industry. A more likely scenario is that industry will adapt and move higher up the value chain, especially with ‘Innovation’ being one of five key areas under the nation’s Thirteenth 5-year Plan that runs from 2016 to 2020.
But as Peter Sengelmann, Senior Portfolio Manager, Emerging Market & Asian Debt (Local Currency & Local Bonds) of Dutch-headquartered NN Investment Partners that managed assets of some €187 billion ($204bn), pointed out late this February: “China is moving at incredible speed, but will slow or accelerate its progress to suit its needs.” (AUM figure cited above was at 31 December 2015).
He contended further: “Much to the chagrin of the rest of the world, the seemingly arbitrary decisions coming from Beijing create uncertainty, but the master plan remains in place with China’s sights set on the end goal.”
It seems like the extreme stock market turmoil has not caused any great harm to China’s economy and the individual Chinese saver. How come?
Despite shares on the Chinese equities markets tanking by around 6% back on 26 January 2016 to reach a then 14-month low, what should be realised is that the stock market in China is not necessarily reflective of the health of the broader economy.
This is due to the fact that many of its biggest enterprises remain in state control and the vast bulk of trading on the Shanghai and Shenzhen stock exchanges is by individual investors. Fundamentally this is the difference between the China and Western economies.
In fact, China’s stock market is small relative to its economy compared to the relationship between exchanges and economies in developed markets. Still, it’s worth noting that the Shanghai Composite index, which closed at just over 2,895 points on 7 March 2016, is down 18.02% year to date (YTD) with the one-year return being -9.06%. This puts the index back where it was in mid-December 2014, but 44% lower than the 5,166 peak set in June last year. So, a big correction and we are not out of the woods yet.
The Chinese authorities have been instituting a multitude of reform changes and in a simultaneous manner - in terms of the country’s economy, stock market and other areas. These measures have been slow and uneven as well as complex. And, it should therefore come as no surprise that they move forward in fits and starts.
The country is now embarking on its Thirteenth 5-year Plan (2016-2020), which spans five pillars. As well as ‘Innovation’ measures already mentioned (i.e. moving up the value chain), the latest plan covers ‘Balancing’ (bridging welfare gaps between cities and the countryside), ‘Opening Up’ (i.e. deeper participation in supranational power structures and more international co-operation), ‘Greening’ (developing environmental technology industry), and ‘Sharing’ (encouraging the people to share the fruits of economic growth).
China’s lower economic growth rate is reflective of the structural readjustments occurring in the economy as it becomes more domestic driven and less reliant on exports. Above all, the overwhelming policy objective is maintaining stability and supporting sustainable growth.
On the savings front, the average Chinese household stashes away c.30% of its disposable income - one of the highest rates in the world. That sounds positive on the surface and handy for rainy days. But with this situation it’s hard to see how consumption will be boosted unless the hooked Chinese savers reassess their approach.
That, said consumption accounts for just over a third (c.35% of GDP). By comparison the average savings rate for US households was recently put at around 5%-6% of income, in a country where and consumption accounts for c.75% the economy.
Specifically, China’s reforms and initiatives include the liberalisation of the currency, the Renminbi (Yuan), and the opening up of the capital account; greater international involvement in geopolitical matters; domestic financial reforms (e.g. interest rates, local government financing); the ‘One Belt, One Road’ initiative to boost overland and maritime trade routes to central Asia; and, the creation of the Asian Infrastructure Investment Bank. The latter aims to expand China’s global influence.
As previously stated though there will be jitters along the way and for the simple reason: change, which equals uncertainty that spooks markets. China is evolving and the world is not ready for it. This is especially so when the country is not fully open about its intentions. Add to that some critics argue that Beijing’s lack of transparency arises from the fact that it does not know where it wants to go.
Furthermore, figures released early this March showed that Chinese exports recorded their worst showing in six years. Data for February 2016 revealed that the nation’s exports witnessed a 24.5% decline over a year earlier, and imports declined by around 14%.
This export slump again underscores the huge challenges that China’s export-driven model is facing and how domestic demand needs to grow to take up the slack in order to maintain the growth momentum.
Should this not happen, China’s growth is likely to slow considerably and be below the 6.5% target set by the government at the start of this March. So, despite a plethora of reform measures initiated don’t discount more volatility on the markets going forward.