Chinese economy to stabilize in spite of market sell-off

Chinese economy to stabilize in spite of market sell-off
Updated 10 February 2016

Chinese economy to stabilize in spite of market sell-off

Chinese economy to stabilize in spite of market sell-off

Developments in China are affecting markets globally. The economic slowdown and financial instability are part of the problem, but the main reason behind the market slump is Chinese policy. First, policy lacks clarity. At will, regulators have been introducing new rules on the Shanghai stock exchange, which at times backfire, forcing the implementation of counteractive measures.
On the currency front, policymakers are failing to clearly communicate their plans to move from an exchange rate linked to the US dollar to one based on a basket of currencies.
Moreover, details on how the Chinese yuan is set daily remain unclear. Second, policymakers continue to interfere in markets. The set of regulations on the Shanghai stock exchange and the managed devaluation of the yuan is hurting the confidence of global investors who have been calling for less controlled markets.
China is reluctant to open capital markets because of the potential volatility that comes with it, instead fueling worries about investing in a tightly controlled and opaque market. China’s role in global financial markets is becoming increasingly important, having already become the second largest economy in the world, at 15 percent of world GDP from around 10 percent five years ago.
The economic implications of the financial market rout are not as severe as the market may suggest. The Chinese stock market drop will have a limited impact on the real economy. Only 15 percent of Chinese investments is allocated to stocks, compared with more than 40 percent in deposits. The lack of correlation between stocks performance and activity indicators such as GDP, retail sales and industrial production shows that economic performance will not be affected by the market selloff. The currency devaluation will also have limited negative effects on the rest of the economy. In order to manage the depreciation, China has used over $500 billion of foreign reserves in 2015. However, there remains more than $3 trillion in the vaults, giving policymakers enough time to set up a more comprehensive exchange rate mechanism, a root cause behind the outflows. The depreciation, which is expected to continue this year, may hurt the country’s purchasing power and make imported goods more costly, but these effects will be outweighed by the boost on inflation and exports.
Despite investors’ cautiousness about China’s financial markets, the economy has shown signs of resilience in the last few months, suggesting even a possible pick-up in the near term. Industrial production decelerated in 2014, but stabilized last year. The currency’s deprecation is making exports more competitive, which could result in greater industrial activity. Imports of goods to be used for exports, a leading indicator of industrial output, were trending upwards last year. Domestic household demand is also picking up, with retail sales growth bottoming out in the second half of last year, which should result in stronger manufacturing growth of consumer-related goods. Investment in infrastructure has been a drag on economic growth, reflected by the trend of fixed asset investments, mainly in the property sector. However, a recovery in property prices and a surge in new housing projects suggests investments may face a similar trend this year. Liquidity is growing rapidly, as well as financing, which could facilitate the economic recovery.
Most analysts expect the economy to maintain its deceleration path in 2016, however economic data suggests more stability ahead. The volatile financial market will continue to cloud China’s economic position as policy will keep lacking transparency. However, we do expect some more clarity on the foreign exchange mechanism. Investing in Chinese stocks may be risky this year, however the stable economic outlook suggests direct investment in sectors such as property and manufacturing may be fruitful.

— Camille Accad, economist at Asiya Investments Company.