Tag Archives: monetary policy

China Can Now Rattle Global Markets With The Best Of Them

Shanghai Stock Exchange seen in 2009. Photo credit: Aaron Goodman. Licenced under Creative Commons.

BOTH LAST YEAR and early this, global stock markets were fazed by a sharp fall in prices on the Shanghai and Shenzhen exchanges. Chinese equity and currency movements are having an increasing impact on investors everywhere. A new working paper published by the Bank for International Settlements, ‘the central bankers’ central bank’, suggests that China’s influence in this regards is rising to the level of that of the United States in some circumstances.

Market moves in China no longer reverberate just in Asia, the authors argue. However, the growth of financial and economic linkages within Asia raise questions about the pace and extent of financial market spillovers in the region and whether there are substantive differences in those flowing out of China to those from the United States.

Empirical study is only starting in this area, though the anecdotal evidence of the effects of financial market shocks is growing steadily. Chang Shu and her colleagues in the bank’s Monetary and Economic Department conclude that China’s influence in this regard has been growing significantly in recent years. This is especially true of equity and currency movements, as increasing financial linkages supplement extensive trade ones established by China’s central position in Asian supply chains.

A working paper from the IMF published last month came to a similar conclusion.

However, that has not diminished the importance of the United States, which also has impact across all asset classes including bonds, and particularly at times of market stress. China’s global financial linkages, though growing, remain modest compared to the United States’ not least because China’s capital account is not fully liberalised. Chinese monetary policy is nowhere near as potent a driver of global liquidity as the US Federal Reserve’s.

For investors, the implication of the work is that diversification of portfolios through Asia investment is becoming less effective at mitigating risk because Asian market movements are now driven by external factors to a greater degree than before.

For regional policymakers, the findings pose the challenge that yield-seeking capital flows to their country (and their exit) will be driven by developments in both Chinese and US financial markets, often in a mutually reinforcing way that could undermine macroeconomic and financial stability in vulnerable economies. It will likely take the emergence of intraregional institutional investors to weaken that linkage.

Leave a comment

Filed under Markets

Markets Expose China’s Inherent Economic Contradiction

100 yuan notes

THE RECENT VOLATILITY in financial markets has brought into question the capacity and nerve of China’s policymakers when confronted with variables they cannot control politically. This heightens concern not so much about the gathering pace of the economic slowdown as about the country’s prospects for the next stage of the economy’s d development, ‘rebalancing’ away from export and capital investment-driven growth and towards domestic consumption.

In what was mostly a closed economy, policymakers had relatively few monetary and fiscal levers to pull, but they were effective when yanked. Administrative guidance was particularly efficient. As the financial system has been opened up, the less guidable animal spirits of market forces have come more destabilisingly into play. The new tools to control them have arrived piecemeal, an inevitable consequence of the deliberately measured pace of financial-sector liberalization.

The currency has been in the vanguard of the reforms in lockstep with freer capital flows, moving steadily along the path of full convertibility, whose final destination has allowed the yuan to achieve the accolade of inclusion in the International Monetary Fund’s basket of reserve currencies.

The People’s Bank of China has a deserved reputation in financial circles around the world for the high calibre of its officials. But even their competency has been questioned following their uneasy and unexpected guided devaluation of recent weeks and their attempts to bring the tightly managed onshore and market-driven offshore exchange rates into alignment, a move undertaken for SDR-related reasons as much as currency management, but done with a tin ear for timing.

The central bank’s switch to managing the yuan’s value against a basket of currencies was both poorly signaled and sent mixed signals to investors, who tend to focus on the exchange rate against the dollar.  If investors lose confidence in the central bank’s effectiveness in the execution of monetary policy, it will only feed the volatility of the equity markets, where officials have already revealed a far from sure touch in their attempts to stabilize the markets.

While it may be virgin territory for many of them, policymakers clearly miscalculated the linkage between tumbling equity prices and speculative pressure on the currency, and how quickly the currency would become the focal point of market unease about China’s economic prospects among investors. It also says something about how the world has changed that the competency of Chinese policymakers has supplanted U.S. monetary policy as the primary determinant of global investor sentiment.

It is the nature of financial markets to be volatile in greater or less degree. Policymakers will learn by experience the limits of their reach in such an environment. Three decades of history will have left them more naturally inclined to intervene than not, which will make that learning painful and slow — last summer’s lessons from the mishandling of the stock-market plunge were clearly not well learned this most recent time round.

However, the broader concern to this Bystander is that financial-market turbulence will encourage Beijing to backslide on further financial-sector reform and more broadly on rebalancing. For some months, it has been dialing back on talking up the need to reduce government intervention in the economy. The third Party plenum at which the top leadership pledged to give market competition a decisive role in the economy seems longer ago than the 30 months it was.

Similarly, the notions that powerful bureaucrats can be a panacea for all economic ills and that the state can trump the market are fading. With that will come doubts in the some senior minds that the Party can pull off the unprecedented trick of liberalizing China’s economy without doing the same to its political system, unacceptable to the Party though the later is.

The certainty that state control provides versus the benefits that free markets bring is the inherent contradiction that may have been manageable for the past 30 years of the economy’s modernization but which, as Japan and South Korea have shown on a smaller scale, becomes more not less contradictory as an economy advances and becomes too big and complex to answer to political imperatives — and to the bureaucrats imposing them.

Leave a comment

Filed under Economy, Markets, Uncategorized

China’s State-Owned Debt Problem

WHEN, AS IS expected later this year, the U.S. Federal Reserve starts to raise interest rates, it will put renewed strain on emerging economies’ debt management. Those most vulnerable are countries with high levels of dollar-denominated external debt and those with high public debt.

Where does that leave China? As so often, slightly oddly placed.

China’s external debt exposure is low. Foreign debt is estimated to be equivalent to less than 10% of GDP. That modest figure by international standards is because China funded its infrastructure building domestically and not by borrowing from abroad. Thus it has avoided one of the textbook potential triggers of an emerging market debt crisis. It helps that China has a financial system that is semi-detached from global capital markets.

On the other hand, China’s domestic borrowing is huge. Total debt, including debt of the financial sector, nearly quadrupled between 2007 and 2014, by the reckoning of the McKinsey Global Institute (MGI), rising from $7.4 trillion to $28.2 trillion, or from 158% of GDP to 282%. This increase was a consequence of the investment-driven stimulus Beijing launched to offset the 2008 global financial crisis and which was funded by bank credit, albeit domestic not external borrowing.

That new debt was largely taken on by non-financial corporations. MGI calculates that that set’s debt accounts for 125% of GDP. Rating agency Standard & Poor’s estimates that China surpassed the United States as the largest corporate debt borrower in 2013.

China’s non-financial corporations are a broad church, however. Their debt is concentrated within state-owned enterprises, not anymore in private companies with the one significant exception of firms in the property sector. MGI estimates that approaching half of non-financial corporate debt connects in some way to real estate development, with 60 firms accounting for two-thirds of it.

An IMF Working Paper on corporate indebtedness in China published by Mali Chivakul and W. Raphael Lam in March puts it thus, “while leverage on average is not high, there is a fat tail of highly leveraged firms accounting for a significant share of total corporate debt, mainly concentrated in the real estate and construction sector and state-owned enterprises in general.”

Chivakul and Lam go on to argue that development and construction firms could withstand a modest interest rate shock, but other corporations in the wider economy would feel the knock-on effect of a slowdown in the property sector. “The share of debt that would be in financial distress would rise to about a quarter of total listed-firm debt in the event of a 20% decline in real estate and construction profits,” they say.

A separate report from economists at the Hong Kong Monetary Authority comes up with a similar analysis — that China’s debt problem is largely an SEO debt problem — and points the finger at  ‘policy driven lending’. “SOEs’ leveraging has been mainly driven by implicit government support amid lower funding costs than private enterprises,” they say.

There is now less such politically driven new lending than before. That partly reflects the passing of the post-2008 stimulus but also a recognition that private firms create the new jobs that are critical to social stability. It also reflects the shuttering, particularly since 2012, of small, inefficient and heavily polluting and indebted SOEs in industries such as steel, cement and mining.

A further round of such ‘SOE reform’ seems likely. And to this Bystander, the corruption investigations into SOEs seems in part an attempt to accelerate those reforms, given that  SEOs are seen as acting as a drag on the wider push for reform and economic rebalancing.

From SOEs it is but a short step to China’s other deep pool of domestic-debt concern — local government borrowing. Outstanding debt has reportedly reached 16 trillion yuan ($2.6 trillion), up 47% from June 2013. Overall, government debt is equivalent to 55% of GDP, again not a concerning high level by international standards. But it is concentrated in pockets, closely tied to real estate, and a further drag on an already slowing economy.

Beijing has both the political will and the financial wherewithal to underwrite local government defaults and forestall any threat of financial systemic risk. However, policy makers will use the mere hint of it to push local government finance reform and deepening municipal bond markets.

Local governments have relied on land sales for revenue, and also seek to turn a yuan from commercial activities conducted through captive off-balance-sheet special financing vehicles, which have borrowed heavily from both mainstream and shadow banks. So the threat of contaigion is real. Rising interest rates will only make it more so, and aid the cause of local government finance reform.

1 Comment

Filed under Economy

China Adds More Speed Bumps To The Road To Rebalancing

THE PEOPLE’S BANK of China has reportedly injected some 500 billion yuan into the five biggest commercial banks in the form of short-term low-interest loans. This can best be regarded as a targeted monetary easing to perk up an economy at risk of falling short of its official target of 7.5% annual growth following a run of soft monthly economic indicators. Four months of a weakening property market, in particular, has culminated in noticeable economic sluggishness since mid-August.

Taking such action ahead of the October national day holiday, during which the banks traditionally face high cash withdrawals, gives the central bank a fig leaf from behind which to claim, should it be of a mind to explain its motives, that it is not indulging in old-school stimulus. Much of the new loans is likely to end up in the real estate sector and funding new infrastructure, however, and thus lay down more speed bumps along the road to rebalancing the economy.

Leave a comment

Filed under Economy, Uncategorized

China’s Second-Quarter GDP Growth Exceeds Expectations

CHINA’S SECOND-QUARTER growth came in at a slightly better-than-expected 7.5%. That is 0.1 percentage points up on the first quarter. Thank a series of targeted stimulus measures for that. Both retail sales and industrial production rose in the quarter.

With the stimulus effects likely to carry over to the third quarter, the official target of 7.5% GDP growth for the full year is back on track. Additional stimulus is unlikely for now except in the slowest growing provinces, where local authorities are still spending heavily, old school.

Low inflation leaves Beijing with some monetary policy flexibility, but cutting interest rates or banks’ reserve requirements to help business get more credit has to be balanced against reigniting asset prices, particularly property.

Leave a comment

Filed under Economy

China’s Slowing Manufacturing Activity Tests Policymakers’ Resolve

So far China’s new leadership has resisted short-term fixes to the country’s slower growth and held true to the need for deeper structural reforms to rebalance the economy. The latest measure of economic activity — HSBC’s flash purchasing managers’ index for May — may test their resolve, but not, this Bystander hazards, break it.

The May reading, at 49.6, down from April’s 50.4, was the lowest in seven months. More germanely, it fell below the 50 mark that delineates expansion from contraction. The modest expansion of manufacturing activity that has been seen since the slowing economy started to pick up steam again last autumn has been replaced by modest contraction. The second area of concern is that the weakness seen by China’s manufacturers in global demand for their goods and services seems to have spread to their domestic customers.

The difficulty for policymakers is that they have limited scope even for short-term fixes. Monetary policy is already easy and loosening it further or splashing out on another round of government funded infrastructure investment spending risks further inflating property bubbles and an already concerning local government debt overhang. At best there is likely to be spot stimulus measures applied where local employment conditions put social stability at risk.

One of the vehicles for this might be the new leadership’s urbanization plans, a centerpiece of its long-term management of moving China to a slower growth trajectory than the double digit annual growth it averaged over the past three decades. While the plan will take years to implement, it could set a tone for structural reform that would have a more immediate effect on economic confidence, and prevent GDP growth for the year falling below 2012’s 7.8%, its slowest in more than a decade.

1 Comment

Filed under Economy

Fragile Industrial Output Tests China’s Policymakers’ Nerve

Economic activity remains weak in China. April’s industrial output was up 9.3% in April from March’s 8.9%, a seven-month low, but short of expectations of 9.5% growth. The recovery that started in the second half of last year is not gathering any momentum. Second-quarter growth is on track to be little better than the first quarter’s 7.7%, and likely less than 8%.

That is testing policymakers’ patience. They would like to stimulate short-term growth, but are already  running loose monetary policy. Any further loosening risks pushing up consumer prices and further inflating asset bubbles, particularly property prices. Meanwhile, state-led infrastructure construction spending, which has been a big driver of growth since the 2008 global financial crisis, is running out of steam and effectiveness, and the debt overhang, as much as 20 trillion yuan ($3.25 trillion), is a worry in Beijing.

The temptation, particularly for provincial and local officials, is to fall back on the tried and trusted remedy to provide a short-term boost to growth, but that also delays the necessary long-term rebalancing of the economy to which the new leadership repeatedly says it is committed. For now, policy makers are likely to stay their course, but they badly need some growth to steady their nerves. With the global economy sluggish, that is more out of their hands than they would like.

1 Comment

Filed under Economy