The bears got it wrong on China
JAN 29, 2016, 5:00 AM SGT
Source –Straits Times, published Jan 29, 2016
2016 welcomed the global economy with a meltdown in China. Barely three weeks into the new year, the Shanghai Composite is down 15 per cent, the yuan has lost 1.5 per cent of its value and fourth-quarter gross domestic product (GDP) numbers released on Jan 19 were at 6.8 per cent, the lowest in 25 years. The question now remains: Is the China success story over?
For more than three decades, China had experienced double-digit export-led growth, resulting in the creation of the world’s second-largest economy.
Today, however, the underlying fundamentals that helped China’s growth have changed. A growing and demanding educated middle-class base can no longer be relied on for a model of exporting cheap labour and mass manufacturing. Investors, sensing that the fuel that drove the economy is about to fizzle out, have struck pre-emptively, deciding to move capital out of the Chinese markets, thereby leading to the rapid sell-off.
The above behaviour negates the assumption in economic theory that investors act in a rational manner. If market participants were indeed rational, the first question they would have asked is: “What are China’s long-term prospects for sustained economic growth?”
According to Nobel prize-winning economist Joseph Stiglitz, “there’s always been a gap between what’s happening in the real economy and financial markets. What’s happening in China is a slowdown by all accounts but it’s not a cataclysmic slowdown”.
To counter the market sell-off, the Chinese central bank, the People’s Bank of China (PBOC), has intervened repeatedly since the beginning of the year, both in the equity and currency markets.
The One Belt, One Road project is a plan for China to build an economic corridor consisting of an overland and a maritime route running through Central Asiaand to Europe.
The Chinese authorities realise that transiting from an export-led growth model that has exhausted itself to a new model based on domestic consumption will cause a short- to medium-term correction in the markets.
Therefore, the decision by the PBOC to intervene was primarily made to avoid an irrational sell-off in the markets and instead allow for a gradual correction to take place to the right levels.
There is little doubt that China’s strategic plan to transform its growth model from a manufacturing export model to one that creates regional and global infrastructure fuelled by its own capital surplus is brilliant strategy.
Unfortunately, the more the Chinese intervene, the more sceptical the global markets become. Professor Christopher Balding at Peking University said: “The real question is whether China is going to allow the RMB to be freely traded at a market price. Right now, there’re some real questions about that and investors in Hong Kong are definitely concerned.”
A FAILURE TO COMMUNICATE
The crux of the issue here is that there is a divide between PBOC’s intentions and market perception.
Market participants have not always reacted negatively to intervention. In 1998, the Federal Reserve and the Bank of Japan (BOJ) made history by jointly intervening to drive dollar-yen from 144 to 105 in a matter of minutes. The markets never fought back. They accepted that a weaker dollar-yen was the new reality. The main reason for market acceptance was that both the Fed and the BOJ took time to explain their logic behind the intervention.
This is exactly what China needs: a strong mechanism to convey the logic and purpose of its policy decisions to the rest of the global markets. Ideally, the Chinese could use a Ben Bernanke, the United States Federal Reserve chairman from 2006 to 2014 , who is capable of articulating government vision and policy decisions to the global audience in a clear manner, and preferably in English.
It worked with the Japanese in the 1990s. Mr Eusike Sakakibara, the vice-finance minister of Japan, spoke with such authority and command that he earned the respect of the global financial community.
The one person within the Chinese government who could potentially fill this role would be the vice-chairman of the China Securities Regulatory Commission, Mr Fang Xinghai,a Stanford graduate who impressed global audiences earlier this week at Davos.
Unfortunately as it stands today, there is very little clarity on China’s policy decisions and no formal platform that allows global market participants to raise their concerns to the Chinese authorities.
NEXT GROWTH MODEL: GO WEST
Before one dismisses China and jumps on the frenzied selling bandwagon, it is important to look at what arsenal China has at its disposal. President Xi Jinping, having anticipated a decline in export-led growth, had put in place strategies which could allow China to sustain its growth in the long run by using its excess manufacturing capacity for offshore projects, and allowing for full utilisation of its capital and reserves to fund such projects. This was the motivation for his brainchild project, now termed as “One Belt, One Road” (OBOR), which originated in 2013.
The OBOR project is essentially a plan for China to build an economic corridor consisting of an overland and a maritime route running through Central Asia and to Europe. The route would encompass 65 countries, with a population of 4.4 billion accounting for 29 per cent of global GDP.
This is an ideal initiative to embark on if China wants to transform its economy, currently based on primary and secondary production, towards a longer-term vision of building much needed infrastructure across Asia, Africa and parts of Europe.
The projected investment for OBOR is about US$1.4 trillion (S$2 trillion), according to Chinese publication China Dialogue, with much of the financing to be done using offshore yuan sourced through the China-led Asian Infrastructure Investment Bank and its 57 members.
There is little doubt that China’s strategic plan to transform its growth model from a manufacturing export model to one that creates regional and global infrastructure fuelled by its own capital surplus is brilliant strategy. Along with revitalising its factories and labour force, it will meet the objectives of building regional cooperation as well as promoting the use of its offshore yuan.
IGNORE THE SHORT-TERM BEARS
There is a clear contrast between China’s methodical long-term strategic planning and today’s shortsighted investors who are mainly driven by short-term returns and quarterly earnings. At the end of the day, China is still growing at 6.9 per cent a year, which is still far above the US at 2.4 per cent, Japan at 0.4 per cent, Europe at 0.8 per cent and Asean at 4.6 per cent.
Moreover, the national savings rate is close to 50 per cent of GDP and only 15 per cent of Chinese households are invested in the stock market.
China has huge reserves, a sizeable domestic savings base, strong manufacturing capacity and ambitious plans to build unprecedented infrastructure across three continents.
The short-term investors may pull their money out of the Chinese stock markets and the Western media may have a field day with doomsday scenarios, but the Chinese authorities should stay focused on their existing reforms and achieving their long-term strategic plans, along with explaining their policy objectives clearly to the global community.
Perhaps this is the right time to reflect on the late Deng Xiaoping’s words: “Keep a cool head and maintain a low profile.Never take the lead – but aim to do something big.”
• The writer is managing director of Deriv Asia, a technical consultancy specialising in OTC (over-the-counter) derivatives markets and risk management .