ECONOMIC OUTLOOK: Dark skies ahead?

The chaos in China’s stock market this summer led some pessimistic analysts to predict a financial crisis. Dave Waller finds that there are positive signs amid the dark clouds.

The words ‘Black Monday’ never suggest the cheeriest start to a week. For China, the darkness is still unfolding. Having slumped its way into a volatile summer, the country’s stock market nosedived on August 24, shedding 8.5% of its value in one day. Prices plunged on the Tuesday too. The Shanghai Composite Index is now about 40% lower than it was in June. 

As we’re talking about the world’s second-largest economy here, it shouldn’t be a surprise that the turbulence, in the shape of a $5 trillion (€4.5 trillion)slide in equities, had an impact elsewhere. The ripples wiped almost £74 billion (€100 billion) from the value of the FTSE 100, before helping the US Federal Reserve decide to hold back from raising interest rates from a record low in September. Fears of a Chinese-inspired downturn also saw prices fall for copper, iron ore and crude oil.

This has naturally bred widespread concern over the future of China’s economy. Slowing growth has been common knowledge for long enough.

Now, many have leapt to the inevitable follow-up question: will there be a full-blown financial crisis in China?

The Chinese economy is never the easiest to get a reliable view on, but it’s fair to say that while the official view may be worth taking with a pinch of salt, so the panic around a potential economic crisis there may be worth tempering too. China’s stock market is still small, its economy still dominated by state banks and publicly owned corporations – so its financial system isn’t as vulnerable to such a stock market wobble as those in the West would be.

Research by the China Beige Book (CBB) found that while the economy slowed in the third quarter, there were no signs of an impending growth collapse. “In the aftermath of the stock market collapse… global sentiment on China has veered sharply bearish,” Leland Miller, president of CBB told news outlets at the time. “Too bearish.” 

The CBB releases a quarterly private sector survey, taking its lead from the US Federal Reserve’s ‘Beige Book’ and based on interviews with more than 2,100 Chinese companies, in sectors ranging from retail to real estate. It found the following: corporate revenue growth in the third quarter actually improved over the first quarter and was stable in on-year terms; the services sector compared favourably both to the previous quarter and the previous year in revenues, pricing, volumes and capital expenditure; transport saw modest revenue gains, both on-quarter and on-year; and the mining sector picked up, with on-quarter revenue gains indicating demand strength in parts of the economy.

And while some fear a systemic aspect to any outflow, other elements suggest this is not the case. “One key indicator is the property market,” says David Gaud, senior fund manager at Edmond de Rothschild Asset Management. “There was a bit of a slowdown, especially in investment in property, but in terms of sales, things have picked up since May and this carried on through the summer. People were worried that the collapse in stocks could have a negative impact on property, but it’s holding up very well – as is the bond market.

“The systemic aspect is not prevailing now and, rather than feeling like a looming financial crisis, it should in fact help more and more global investors come to China and be more active in investments here.” 

One of the key fears around a stock market crash is, of course, the flight of international capital. UK chancellor George Osborne addressed this in September when he appeared in Shanghai, pledging not to “run away from China” despite the turmoil. Instead, he confirmed plans for a stock market link, which would allow brokers in London to invest directly in Chinese shares.

“The world is worried about China, but even if foreign investors really turned their back on the market it wouldn’t have a massive effect,” says Gaud. “Foreign investors aren’t actually that big a presence in the Chinese market.” Indeed, foreign investors own just 2% of Chinese shares.

But what about domestic investors? Some of the millions of Chinese investors who borrowed money to enter the markets were hit hard. But it’s worth remembering the size of the country’s population: only one person in 30 in China actually owns any shares. Economists estimate that stocks make up only 15%- 20% of Chinese household wealth. 

“Look at where people put their wealth in China,” says Gaud. “It’s the property market and short-term products. Are we at the point where they don’t believe in the economy and are trying every means they can to escape? Clearly not.” 

One reason Chinese people won’t pull their money out of the country is that there isn’t a better option overseas. Plus, the government is still very keen on capital controls: if there was a panic it would no doubt act to stop it. Even though Chinese president Xi Jinping came out to reassure the world that the government was still firmly committed to financial reform, he has shown no shyness in intervening to steady markets. Indeed, the government’s measures aimed at shaking out speculators showed evidence of doing just this. 

Similarly, state councillor Yang Jiechi told reporters in early September that “some movements on the stock exchange in China should not equal the whole picture of the Chinese economy”. Indeed, if the government’s growth forecast of 7% is to be believed, China is still growing far faster than the likes of the UK or US. Osborne himself described the potential growth as one that would “add to the world economy an economy the size of the United Kingdom at least. So the growth in the Chinese economy will be more than the entire British economy at least in the coming five years.” The Asian Development Bank said it expected China’s economy to grow 6.8% this year. In other words, it’s suffering the kind of economic problem the rest of the world would be happy to have.

Of course, the job isn’t a simple one for the Chinese authorities. They’re charged with the task of steering an enormous economy away from over-dependence on investment, exports and an overvalued property market, towards one driven by greater household consumption. This won’t be without its bumps. 

The International Monetary Fund has urged China to make further structural reforms: to make the move to a more market-based financial system, to reform state-owned enterprises, and introduce an effectively floating exchange rate.

China stock prices have stabilised at the time of writing, a further sign of improving investor sentiment. So while no one can read the future, and even though there are dark clouds in Chinese skies right now, we may not see a financial crisis in China just yet.

©2015 funds europe



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