once again, financial markets are painting an oversimplified picture of a very complex story. China is being blamed for everything from the recent rout in global equity markets to the next recession.
While China’s scale and cross-border connectivity are not to be minimised, its global impacts are far more subtle. At work is a tug-of-war between two powerful forces: the country’s long telegraphed transition to a new growth model and the necessary development of a robust financial infrastructure.
Contrary to widespread opinion, China is making reasonably good progress on the first count, especially in shifting the structure of its economy from manufacturing to services. These shifts are far more important than the inordinate fixation on headline gross domestic product. A misplaced obsession with the statistical accuracy of total growth misses this crucial point as well.
The demise of the commodity supercycle is a tougher repercussion. Momentum-driven investors — as well as resource economies such as Brazil, Russia, Australia and Canada — were slow to see the significance of China’s shift from commodity-intensive growth.
Oil is the most obvious example. Yes, coal accounts for about 70 per cent of total Chinese energy consumption. But the country’s role in driving world oil demand is also crucial. In the decade ending in 2014, growth in Chinese consumption accounted for 48 per cent of the total growth in global oil demand.
China’s reduced consumption of oil, as it shifts to slower growth led by low-carbon services, explains much of the recent collapse in crude prices. A similar effect can be seen on the prices of base metals and other industrial materials.
Notwithstanding China’s early progress in the rebalancing of its real economy, there have been significant setbacks on the road to financial reform. China’s equity market fiasco of 2015, which has intensified in the early days of 2016 and spilled over to other major bourses with a vengeance, tops that list.
The country’s regulators and senior officials were complacent as a monstrous bubble inflated in the first half of 2015. They have bungled attempts to stabilise the market as the bubble burst in the past six months. On-off attempts at state-directed equity purchases, stock market circuit-breakers and other controls have left regulators confused and discredited.
The deeper problem is not the bursting of the bubble itself but what it means for financial reform imperatives. Chinese credit flows have long been too reliant on banks and development of alternative funding through capital markets has been made a priority. With a nascent bond market too small to fill that void, focus turned to the development of a sound equity market. With the stock market unhinged, that option has now been discredited. For a leadership that made a public commitment to the decisive role of market-based reforms, this is a big disappointment.
Beijing’s currency policy is a different matter altogether. Investors are drawing the incorrect conclusion that the recent depreciation of the renminbi versus the dollar portends a new round of competitive devaluations, which might spark a full-blown currency war reminiscent of Asia’s lethal contagion during the crisis of the late 1990s that pushed the region into deep recession and threatened to do the same to the world.
This is highly unlikely. After a decade of sharp appreciation, the renminbi is now closer to fair value. China’s formerly outsized current account surplus has been reduced, taking pressure off the currency to force further adjustments. Indeed, while the renminbi is down 6 per cent against the dollar since July last year, it is still up 25 per cent relative to mid-2005. Against a broad basket of China’s trading partners the so-called real effective exchange rate remains about 50 per cent above levels a decade ago.
While this suggests there is ample justification for China to temper the sharp renminbi appreciation of recent years, the likelihood of a more disruptive reversal remains low. First, in a sluggish global economy, it would take a considerably larger depreciation to boost exports enough to offset downward pressures elsewhere in China. Second, such a devaluation would contradict Beijing’s core strategy of moving from exports toward domestic consumption.
Finally, aggressive depreciation could spark a backlash against the recent decision of the International Monetary Fund to include the renminbi in its special drawing rights regime.
China certainly has many other challenges, from excess debt and property market imbalances to industrial over挀愀瀀愀挀椀琀礀 and environmental degradation. Fortunately, these problems figure prominently in internal policy debates. The far bigger task is the balancing act between economic and financial restructuring. Progress in economic rebalancing will be stymied if capital markets reforms continue to flounder.
Meanwhile, global markets need to take a deep breath. The good news is that fears of a Chinese hard landing are overblown. For oversold markets, that could provide welcome relief. The bad news is that central banks are starting to wean markets from the artificial support of years of unprecedented quantitative easing. In the end, that could prove far more problematic than another China scare.