September 2, 2015    5 minute read

What’s Next For China?

What’s Next For China?

Stock market turmoil in China may not necessarily spell calamity for its economy, however it does certainly raise many questions about the ability of its economic and financial policy to succeed.

Context

Rewind back to the 24th August, Black Monday, markets around the world were faltering, panicking, and in a state of crisis. European, American and Asian markets were all down, and commodity prices were back to where they were prior to the 2000s commodity price boom, whilst safe-haven stocks were in steep demand. The cause of this shock; a bursting stock bubble within the Chinese stock market, an act that has deeply affected the perception by financiers around the world that

“China’s authoritarian leaders were the world’s most competent technocrats”

Jamil Anderlini, FT

Problems ahead for the Chinese State economy

Masses of economists are advocates of the theory that the Chinese economy is simply in a stage of correction, as opposed to a “great fall”. Yet it is hard to discount the fact that there are numerous obstacles ahead of the Chinese state, and the success of its economy.

Take the case of global investor confidence. If global investors do not have faith in the policy makers of the largest global economies, it is particularly difficult for the financial plans or reforms to work. This is because in order for a reform plan to trigger the actions that are required for success to follow, the investors must buy-in to it. Furthermore, given the actions of the PBoC (People’s Bank of China) in recent times, there’s very little reason for investors to hold confidence in the institutions ability to create a successful reform plan. The surprising currency devaluation of the 11th of August, alongside the recent contradictory monetary policy, will have only weakened the confidence that financiers hold in the central bank. 

Moreover, China has an almighty mess to mop up from before the Black Monday episode even occurred. In 2009 the Chinese State unleashed a substantial stimulus package, when it attempted to suppress the effects of the global financial crisis, by going on a spending spree. The magnitude of this package must not be underestimated as it is believed to have been in the region of RMB4 trillion – or ($586 billion). As a consequence, debt has reached more than 250% of GDP according to data presented in the Economist. Thus there is also a considerable rebalancing act that must occur.

As if China wasn’t already facing a large enough challenge, it too must cope with the statistic that the working age population of the nation is now in decline. Given the fact that the large population size, and growth in population size, are two fundamental reasons why their economy has been able to grow in an almost unprecedented manner, this is a big concern for the Chinese State. Yet this is a problem that cannot be met with an immediate solution for obvious reasons.

Chinese working age population year-on-year change 

Evidently therefore, there are numerous headaches ahead for the Chinese authoritarian leaders. But what are the possible steps they can take in the impending weeks and months?

Immediate response by the PBoC

Stephen Ma, head of greater China equities at BMO Global Asset Management declared,

“Real interest rates have been very high in China, (so) they should focus on cutting interest rates or the RRR (reserve requirement ratio), that should improve consumption and corporate earnings”

However, the People’s Bank of China already cut its benchmark lending rate 4 times between November 2014 and June 2015, with virtually no success. This can be seen in the Caixin flash manufacturing purchasing managers’ index (PMI), a significant indicator of China’s manufacturing sector, dropping in August 2015 to its lowest point since 2009. Despite this lack of success, many economists expected another round of interest rate cuts to come, and this arrived on the 25th August, with the rate dropping to 4.6 percent. Alongside this reduction in the base rate came a reduction in the RRR too.

PBoC one-year benchmark lending rate

An important question

Jamil Anderlini proposes the argument in the FT Big Read on China that if the Chinese were in considerable economic bother, the Premier and President would’ve been more proactive in calming the markets than they were. Instead, they were focusing their attention on crushing the followers of the Dalai Lama, and developing China’s 3D printing industry.

Yet if the Chinese were in fact on course to achieve the target 7 percent growth this year, it doesn’t make sense that they engaged in a surprise devaluation of the Yuan, and cut interest rates, does it? Gordon Chang, author of ‘The Coming Collapse of China,’ reports that

“China could be in the world’s greatest depression and they would still report 7%”

This raises a series of very significant questions. Is the outside world being made blind of the economic and financial situation within China? Maybe. Is this for the moment a temporary solution from the PBoC? Maybe. But can this blow over without a calamitous effect occurring on the economic and financial world as a whole? No. China is set to become the largest economy in the world imminently, so to think a depression in such a nation can be suppressed to relieve the rest of the financial and economic world is not only naive, but also almost certainly impossible.

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