If one were asked to suggest an apt word to describe the state in which the Chinese economy has found itself over the past few months, the terms slump, disarray or even meltdown could very well be contenders.
Following the decision in August by the People’s Bank of China (PBoC) to devalue the yuan for the first time since 1994, the Chinese economy experienced a series of startling developments, including a sharp fall in the value of Chinese shares, a 50 percent drop in market capitalisations over a two-month period, and an attempt by the Beijing government to reassure investors by allowing its main state pension fund to invest in the stock market. All of this, remembering that China is the second largest economy in the world, sent shockwaves around the globe with shares tumbling to the tune of hundreds of billions in Europe, Asia and the US.
Quite simply, the Chinese economy is in a serious state of flux. There are demands for answers, not only in terms of dealing with the immediate impact of the crisis, but, going forward, just what needs to be done to successfully retool the Chinese economy.
The issues facing the Chinese economy in 2015 have been immense and many have been seeking the reasons why this economic superpower has gone so spectacularly off the rails. “The Chinese economy faces several big hurdles,” explains Professor Ann Lee, an adjunct professor of economics and finance at New York University. “First, it still has to lift hundreds of millions of people out of grinding poverty by creating enough jobs to absorb the migrant and rural population. Second, it must ensure that the economy creates enough high end jobs to absorb the growing educated population so that the perception of class mobility is still intact to avoid social unrest. Third, it must manage this economic growth without creating undue inflation or deflation. Fourth, it must find a way to grow the economy while reducing pollution levels because of the unsustainability of relying on carbon-based growth factors.”
Difficulties such as these are simply par for the course in China. They are not unsolvable, but a solution will take time and a process of trial and error on the part of the Chinese authorities.
Whether the sudden devaluation of the yuan in August 2015 will prove to be the precursor to a sustained decline depends very much on the motivation of the PBoC according to Nicholas Millikan, a client portfolio manager at Forward. “If it is an attempt to arrest cyclical weakness by boosting the flailing export industry, this could further ignite concerns of a deeper slowdown and lead to more significant capital outflows, placing further downward pressure on the Yuan in the short-term,” he says. “However, if it’s a structural shift, an effort to decouple their economy from the US, this will allow both the PBoC and the Fed to pursue more independent policy and likely achieve greater global economic stability over the long-term.”
To retool the Chinese economy, the PBoC has a number of options available to it. The relatively high interest rates in China could be lowered to stimulate more borrowing. Lowering the interest rates may also devalue the yuan, thus levelling the playing field for exporters. The PBoC could also lower reserve requirements or engage in other stimulative actions. These policy measures, whilst credible, are unnecessary, believes Professor Lee. “What I think will get things going is simply allowing more time for the base of Chinese middle class consumers to grow and the cooperation of developing countries to allow China’s proposal to build their infrastructure,” she says.
Whilst the nature of the retooling process has yet to be determined, the weakened Chinese economy has far reaching implications for global markets. “In the US for example, the Fed’s July meeting minutes showed that officials are concerned about the impact of a slowing China,” says Mr Millikan. “So while the US economy is showing signs of strength in labour markets and growth, nervousness by the Fed could see an accommodation for China’s weakness in setting policy.”
As far as Australia – a key economic partner – is concerned, the impact of Chinese economic strife is far more immediate. “Even if growth does stabilise in China at Beijing’s targeted 7 percent, it’s unlikely that future growth will continue to see such robust demand for Australia’s commodity exports,” suggests Mr Millikan. “The take away here is that the jobs that have been lost certainly won’t be coming back any time soon, if they return at all.”
On this point, Professor Lee notes that the implications for Australia have been in place for some time now. “China is going to invest less in Australia’s infrastructure going forward because it doesn’t need much more investment in that area,” she says.
Conclusion: a lost decade of economic growth?
Although the country has recovered some ground in the past weeks as global markets have taken steps to steady themselves, the credit-fuelled Chinese economy remains fragile, with fears growing of a lost decade of economic growth and a long-term prognosis that is very much up in the air.
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