The slowdown of growth and turbulence on the Chinese markets are having global ramifications…..
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The interventions of the Chinese authorities will also be backed, with words and/or actions, by the central banks of the advanced countries, to contain the risk of a new systemic crisis and of an interruption of the current moderate recovery. External support has already started trickling in, with words from the ECB and signals from the Fed of a likely postponement of the rates lift-off.
– The brutal market correction, triggered by the devaluation of the Chinese exchange rate in mid-August, has spread globally. The initial authorities’ attempts to contain the stock market crash were ineffective; the focus then shifted on the one side to conventional expansionary monetary stimulus (25bp cut of the lending rate to 4.6%, 50bp reduction of the required reserve ratio), and on the other to an attempt to stem capital outflows by further reducing central bank reserves (on the decline for almost one year now).
– The Chinese crisis is rooted in the weakness of the economy, largely due to the misallocation of growth, and to the failed transition to a consumption-driven economy: the result has been overinvestment, also due to chronic producer price deflation, accompanied by a fast-growing debt. The deepening of the slowdown, and the violent correction of the markets, combined with fears of further, sharper depreciation of the exchange rate, has generated fears of a new crisis like the one seen in 1997-98, which spread to the emerging economies. Currently, the fragility of other emerging countries is not only a direct consequence of the slump in Chinese demand, but also of the further drop in commodity prices, which is a positive shock for importer countries (China first among them), but negative for producer countries.
– Despite the depth of the problems faced by Asian countries, and some points in common with the crisis of 1997-‘98 (low real rates, mounting debt, exchange rate depreciation, run-up to the fed funds hike), there are several crucial factors which set 2015 apart from 1997-‘98: most countries boast positive current account balances (except India and Indonesia); the exchange rates are governed by flexible regimes; inflation is low across the board, ruling out the need for interventions on rates in the face of a sharp depreciation of national currencies; currency reserves in all countries are higher than the safety thresholds indicated by the IMF; and most of the debt is in local currency. Obviously, the contraction in currency reserves seen in the past year (estimated at around 60 billion dollars a month for Asia excl. Japan), and especially the swift acceleration recorded in China in the past month, cannot last forever, but allow a margin to rule out a systemic crisis and to rely on conventional stimulus measures.
– The size of the Asia-excl. Japan bloc (around 22% of global GDP in 2014, vs. 10% in 1996) and its contribution to global growth (almost 50% in the past few years) represents another important difference between the 1990’s and now: the crisis may be exported outside the area, but all central banks will act in the same direction, further reducing the risks of a systemic crisis. The effects of the Chinese slowdown, and the markets’ difficulties in adjusting, spread swiftly and significantly to the global economy, prompting reactions from the authorities of the advanced countries as well. The circle is closing: China is selling hundreds of billions of dollars in reserves to counter capital outflows, and the Fed could postpone the rates lift-off, contributing to prevent a repeat of the events of 1997-‘98.
– The ECB and the Fed have already reacted verbally to the market turmoil. For Praet (ECB), QE could be beefed up, as downside risks to inflation have increased. Dudley (Fed) said that the case for a September hike have become “less compelling”, although the domestic picture remains positive. Dudley stressed that short-term market movements would not alter the decision on rates, but “international developments have increased the downside risk to US economic growth somewhat”. Dudley warned that strong data ahead of the meeting could once again change the balance of risks, and said he “really hopes” that rates may be hiked this year (as opposed to his previous “forecast” for a lift-off in 2015). The door is now open for a postponement of the first hike, which could be moved to December/January: Data and the effects of market turbulence are key to monetary policy normalization.
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