2015: The year of blaming China?
December 28, 2015, 5:10 pm

China is moving from an export-based economy to one that is driven by domestic products and services, and consumer spending [Xinhua]

For the past several months, all eyes (and ears) have been on China for a glimpse of what monetary policies will emerge from the world’s second largest economy.

Some emerging market experts say it is China’s waning demand for commodities that has driven their prices down and led to devaluation of their currencies.

Others say that China’s slowing economic growth is part of the reason that the Federal Reserve backed off announcing an interest rate hike in September (and likely October, as well) because it feared the “shock to the system” Chinese markets could have on global trade.

Others pointed at the benchmark Shanghai Composite (SHCOMP) and Hang Seng indices, which suffered considerable losses over the summer, as a sign that China may not meet its projected 7 per cent growth in 2015. China’s economy expanded 7.3 per cent in 2014.

The SHCOMP peaked at 5166 on June 12, 2015 and then plummeted to 2964 on August 25 due to a number of poor economic reports, such as contracting manufacturing growth.

On the surface this appears to indicate that Chinese markets are in disarray and it is easy to see why global markets suffered across-the-board losses which some pundits compared to the ‘crash’ of 2008.

But the SHCOMP has pulled back over the 3500 range in recent weeks (3533 on December 28). And, if one were to compare its performance year-on-year it is actually up 10 per cent from from the same period last year.

The Hang Seng, however, is down less than 5 per cent in the same period, but nothing that should send global traders into a frenzy.

Yes, China’s economy is slowing down but it will not crash. Instead, as International Monetary Fund chief Christian Lagarde said in September, China’s economy is “in transition”.

Others see the Chinese government’s latest fiscal policies as “corrective”.

On September 25, former Federal Reserve Chief Ben Bernanke told CBS News that it is not surprising that China is slowing. He says it was predictable.

“It [the Chinese economy] had to slow … it can’t grow at 10 per cent a year forever,” he said.

“The biggest challenge is to make the transition from an economy based on heavy industry [and] infrastructure [and] exports to a more Westernized style of economy based on a diverse set of industries,” Bernanke added.

The Chinese leadership thinks so, too.

World economic power

China is the world’s second largest economy so it’s no surprise that the world would shake a little if it hiccups.

Such is the nature of the globalized economy.

While China’s slowing economy means its appetite for commodities is waning and therefore contributing to the global slowdown, the same can be said of Europe.

China is not the only factor here.

For example, the continuing decline in energy prices may be a boon for consumers, but is a disaster for oil-rich countries who depend on this export as the dominant foreign cash earner.

Oil exporters are flooding the markets, operating at OPEC’s quota ceiling – and beyond, and the prospect of Iran selling one million more barrels a day once sanctions are lifted is also a likely trigger for lower energy prices.

Yes, it can be argued that higher oil prices would have made the current crisis far worse, but conversely countries like Venezuela, Russia and Indonesia would be able to reap more dollars for their economies and therefore be in a better position.

With their economies so dependent on oil exports, they now have less foreign cash reserves to import goods.

But there are legitimate concerns about China’s economic health.

When Chinese stock markets plummeted in July and again in August, Beijing’s major concern was to meet its target growth rate of 7 per cent in 2015. As a result, it took a series of measures to keep the economy on track.

In early July, China Securities Finance Corporation Limited (CSF), the state-owned margin trading service provider, immediately took measures to prop up the downward spiraling stock market by increasing share purchase and offering brokers liquidity aid.

The CSF provided 260 billion yuan ($41.89 billion) in credit lines to 21 brokerage firms to help them buy stocks via proprietary trading.

Later that month, the People’s Bank of China (PBOC) said in an online statement that it would maintain prudent monetary policy in the second half of this year to ensure that liquidity stays at an appropriate level.

The PBOC also injected 50 billion yuan ($8.05 billion) into the money markets through seven-day reverse bond repurchase agreements.

The measures worked for a while. The benchmark Shanghai Composite index began to rise after its drastic July fall.

In mid-August, Chinese markets tumbled again on weak economic data, such as excess capacity, weaker manufacturing, decline in exports and profit, and lower domestic demand.

The PBOC stepped in and devalued the yuan by three per cent over the course of three days.

That sent markets into a spin with indices across the board in every country falling on suspicion that China’s economy was worse than anticipated.

Chinese authorities stepped in to ease the tension in domestic markets – introducing measures which have stabilized the economy by years-end and are likely to continue playing a role into 2016.

These include cutting interest rates and ensuring there is more cash liquidity in the market – measures similar to those taken by both the Federal Reserve and European Central Bank when they launched quantitative easing programs to pull their regions out of recession.

The PBOC has cut benchmark interest rates five times since last November and lowered banks’ reserve requirement ratio three times since February.

China’s value-added industrial output expanded 6.1 per cent year on year in August, up from 6 per cent in July, the National Bureau of Statistics (NBS) said.

China’s retail sales grew 10.8 per cent year on year to 2.49 trillion yuan ($390.89 billion) in August, higher than forecasts.

In November, the NBS said that rebounding sales, lower costs and higher investment returns helped slow the profit decrease of China’s major industrial firms.

In October, year on year profits decreased by 4.6 per cent; in November, this improved to just 1.4 per cent.

A slowdown or deceleration?

The Fed signaled that it was no longer fearing instability in the Chinese economy, but global investors will be looking for signals of Beijing’s monetary policy and reforms in 2016 [Xinhua]

But there is method to the August mayhem.

As the Fifth Annual Plenary revealed, the Chinese leadership is absolutely determined to shift the economy from one that has been traditionally and solely based on exports and inadequate investments to a robust, albeit slower model for growth based on local markets and consumer spending.

It’s ultimately about sustainability and the Communist leadership looked at the strength of European and other emerging markets and concluded that their weaknesses led to fewer Chinese exports.

Given mediocre global economic growth, an exports-based model is in the long-term unsustainable.

This is the trap many other emerging markets such as Indonesia, Mexico and Brazil have fallen into.

At the Plenary in October, the Communist leadership appeared to accept that GDP growth this year would not meet the 7 per cent target, falling rather to 6.9 per cent.

In hopes of targeting medium to high economic growth by 2020, and seeking to double GDP and per-capita income during that time, the leadership potentially may feel comfortable with growth even lower – say, at 6.5 per cent.

Consequently, the government will likely seek ways to balance micro and macroeconomic restructuring by imposing far less regulation on pricing products and services by 2020.

It is hoped this will empower local authorities in a bid to boost entrepreneurship and domestic innovation, thereby encouraging the economy to be market-driven.

Sustainable global influence

During the global recession sparked by the 2007 subprime mortgage crisis in the US, China was the world’s economic dynamo.

That helped China’s global influence grow.

That was no more evident than during President Xi Jinping’s visit to the US and UK earlier this year.

In both cases, state dinners were thrown for Xi – an honor bestowed on the closest of allies and friends, and the media coverage of the visits reached the peak of frenzy.

Despite differences over territorial disputes in the Pacific, there was an understanding that China could no longer be dismissed as in past decades.

This was also particularly true of China’s currency, the yuan (or renminbi), which this year overtook the yen as the world’s fourth most traded currency.

In early December, the International Monetary Fund announced it would add the yuan to its basket of four reserve currencies, known as Special Drawing Rights, or SDRs. This takes effect on October 1, 2016.

The People’s Bank of China also announced in early December that it would not only peg the yuan against the dollar but also included a parallel index against a basket of 13 other currencies.

More than 100 countries used the yuan for payments in August, of which over 90 percent of flows were concentrated in 10 countries.

The yuan, not the dollar, will also be the currency of choice for the BRICS New Development Bank (NDB), which will announce its first investment in April 2016.

The NDB with about $50 billion in capital to invest in public infrastructure will compete with institutions where the US has considerably more influence—organizations such as the World Bank and the International Monetary Fund.

On December 25, the China-led Asian Infrastructure Investment Bank (AIIB) – which includes founding members the BRICS, half of the European Union (France, Germany, and the UK, to name a few) and all of the Asian bloc, ASEAN – was formally established in Beijing.

With an authorized capital of $100 billion, the AIIB will finance infrastructure projects like the construction of roads, railways, and airports in the Asia-Pacific Region.

By Firas Al-Atraqchi for the BRICS Post with inputs from Agencies