China’s Turbulent Rebalancing

DAMNED CUSSED THINGS, stock markets.

After last summer’s plunge in equities prices on the Shanghai and Shenzhen exchanges, authorities put in place measures to prevent a repeat. Share sales by large shareholders were choked off for six months and ‘circuit breakers’ put in place to halt trading if prices fell by more than 7% in a session to give time for excited animal spirits to calm down.

Yet this week has seen a rerun of last June.

The circuit breakers kicked in twice this week, the second time after just half an hour of trading. The circuit breakers themselves have now been suspended, and sales restrictions on large-scale shareholders extended.

Applying rational explanations for stock price movements always risks being a fool’s errand. What is being said is first that investors at the beginning of the week were rushing to sell stocks in advance of the end of the initial restriction on large-shareholder sales, which was expected to push prices down. Second, that the People’s Bank of China’s repeated setting of the yuan’s exchange rate at the lower end of its band was effectively a managed devaluation of the currency. Third, that weakening the yuan signaled a recognition that the economy was slowing more rapidly than thought and that a beggar-thy-neighbour round of competitive regional currency devaluations was in prospect.

All this has wider implications for the global economy. Equity and commodity prices, particularly of oil, tumbled around the globe.

The bigger concern is that markets are underlining how China’s transition towards more consumption and services-based growth is moving too gradually, and thus domestic consumption is not growing enough to offset the slump in exports caused by the decline in global demand.

On January 6, the World Bank in its newly published Global Economic Prospects forecast that China’s GDP growth would slow to 6.7% this year and 6.5% next, down from 6.9 % last year and 7.3% in 2014. Manufacturing and real estate have borne the brunt of the slowdown. The Bank also warned of the risk that the slowdown could gather pace faster-than-expected.

Sticking a finger of administrative guidance into the dyke of financial markets rarely has a happy outcome. Instead, fiscal and monetary policy will have to stem the flood. We expect to see further lowering of interest rates  and required reserve ratios and additional liquidity injections.

More infrastructure investment by central government is also likely. The fiscal deficit widened to 2.3% of GDP last year, a six-year high, as Beijing’s spending offset cuts in spending at the local government level in the second half of the year. There is still room for manoeuvre on that front.

China’s foreign reserves remain plentiful, too, at 33% of GDP. The current account is in surplus. The rebalancing is underway, as the World Bank’s charts below show, and the growth slowdown is, for the most part, orderly. However, the market turbulence is not, and will continue not to be so for as long as equities are overvalued, no matter how much some authorities think markets should bow to guidance.

China economy graphs

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