China’s hard landing: Are we overreacting?

Much has been said about China, a populous country that has drawn both envy and admiration across the globe as it achieved decades of rapid economic growth by incorporating market-friendly reforms into its centrally-planned economy.  In recent years, the narrative has turned increasingly negative, if not outright scornful, no thanks to China’s failure to articulate many of its policies to the Western world.

Fears of “devaluation” and economic “hard landing” have resonated in all corners of the globe. Since last year, the turmoil behind the Great Wall has started affecting even the US Federal Reserve’s policy-making.

A research note from American investment bank Bank of America Merrill Lynch last Feb. 22 reflected this confusion about China’s policy: “Renminbi internationalization or capital controls? Easy monetary policy or a strong currency? Preserving forex reserves or a new wave of overseas FDI (foreign direct investments)? More competitive private sector or bigger SOE (state-owned enterprises) oligopolies? Financial repression for households—zero percent real deposit rates—or a rising household income to GDP (gross domestic product) ratio that would raise the consumption to GDP ratio? Many questions but few answers.”

A group of economists, who came together to form the Asian Shadow Financial Regulatory Committee (ASFRC), is calling for greater sobriety in looking at this turmoil behind the Great Wall. ASFRC is a pool of experts, mostly from the academe, that seeks to translate concepts drawn from academic literature into concrete policy recommendations.

Orville Jose Solon, dean of the UP School of Economics, where the 27th meeting of the ASFRC was recently held, described ASFRC as the guys who don’t need to be billeted in five-star rooms with a picturesque view of the ocean to do their brainstorming.  The group offers unsolicited views, which don’t necessarily represent those of the institutions its members are affiliated with.

The group believes China is actually suffering more from a PR (public relations) rather than a real economic crisis, aggravated by investors’ tendency to scrutinize this Asian economic giant using “Western” lens.

After their last regional meeting in Manila, ASFRC chair Martin Young issued a committee statement, which asserted that China had been mostly misunderstood by the outside world especially on issues relating to currency devaluation, decline in foreign reserves and the stock market rout.

“These headlines tend to depict an economy in crisis.  This picture has taken hold in global mass media, helping to roil global financial markets already worried by the financial implications of the collapse in oil prices and the limited effectiveness of successive rounds of liquidity injections by leading central banks,” Young said. “China, in our view, made matters worse by failing to explain abrupt shifts in financial policy and personnel.”

He said fears of a hard landing may end up like a self-fulfilling prophecy if this would exacerbate lower rates of investment and hesitance over emerging markets, which in turn would feed into China’s real economy.

Currency devaluation

But the negative impact had been excessive, with the group contending that foreigners harbored a lot of misconceptions about China. In the case of the renminbi, for instance, ASFRC lamented that foreign commentators speak loosely of a “devaluation” when the currency had depreciated against the US dollar by only 4.33 percent over the last 12 months.

“This cannot improve China’s international competitiveness by much. With a current account surplus of $600 billion in 2015, China has little reason to devalue its currency for this purpose,” Young said.

China’s surprise devaluation of the yuan to a three-year low in August 2015 following a string of bleak economic data only escalated growth jitters and, after two weeks, precipitated a global meltdown of stocks on August 24, 2015—now referred to widely as the “Black Monday.” The Philippine Stock Exchange index at that time lost 487.97 points, the biggest decline seen in a single day. This 6.7-percent decline wiped out P764 billion of local market capitalization.

Financial rout

On concerns about China’s declining foreign reserves, the group explained only a small proportion of the $1-trillion reduction constituted classic capital flight. The group noted there were just Chinese corporations repaying US dollar loans while some were switching their renminbi holdings to US dollar holdings.

At the same time, China is boosting overseas investments, which ASFRC said reflected the country’s desire to use trade surpluses to invest in real assets abroad, especially in infrastructure. The group said this would help mop up excess capacity in China’s heavy industries.

On the stock market rout in China, ASFRC said a reduction in consumer demand would happen only if a substantial part of private wealth was correlated with stock market indices.  The group noted only one in every 30 persons in China owns stocks and only 5 percent of personal assets are invested in stocks.

The group added China’s stock market had gone through several cycles of boom and bust without ever disrupting high growth rates.

“There is obviously a communication problem between China and the west,” Young said, adding that China’s broader picture must be appreciated by the outside world. As such, the group urged China to make regular and timely efforts to convey its financial analysis and policies and take advice from experts in Western PR.

ASFRC argued that in organizing the production and allocation of goods, China’s system has proven it is just as successful as the Western system but is performing less well in guiding financial transactions.

“Why the Chinese system works in the case of goods but not in the case of finance cannot be explained via a sound bite, so Western commentators fall back on familiar tropes about Communist dictatorship, corruption and China’s inevitable collapse from a failure to embrace enlightenment values,” the group said.

“This misunderstanding is having real economic consequences, since China’s political economy has grown to the point that it has become a key player in a global financial system built on Western premises.”

Recommendations

Given the urgency of financial reform, ASFRC believes it would be more realistic and useful for China to reform its financial system by taking advantage of its institutional strengths, in particular the way its economy has succeeded by checks and balances within its political hierarchy, such as competition between power centers at the same hierarchical level.

ASFRC said the share portfolios owned by various government units could be organized as exchange-traded funds (ETFs) and citizens could be given the opportunity to buy shares, as long as they receive payouts at the same rate as the controlling government unit.

“State-linked units are already in the business of buying stocks to support the market; they could secure more funds to do so by issuing shares in their ETFs to private citizens.  Speculative trading of these shares could be discouraged by requiring immediate settlement of all trades and/or by a substantial tax on short-term gains,” the group said.

On China’s massive infrastructure spending program called “one-belt-one-road policy,” professor of finance and executive director at Asia-Pacific Institute of Business, Chinese University of Hong Kong Leslie Young said this could be thought of as “the economic expression of the internationalization of the Chinese economy.” Leslie Young is also part of ASFRC.

For traditional Western powers like the Britain and the US, he said the culture and style of political economy had lent itself to globalization, creation and domination of global financial markets.

So, “What space is left for China to expand and grow?” he asked.

Building infrastructure from east to west is a way for China to physically establish itself as a rising economic power.

‘China, in our view, made matters worse by failing to explain abrupt shifts in financial policy and personnel.’