8 / 24
A Small Hiccup
What a start to 2016 !
In response to the sharp
upheaval in the stock market
last year, China introduced
the circuit breaker mechanism
to control extreme volatility.
The mechanism
was triggered as
soon as it came
into effect on 1
Jan 2016, and
then again 3 days
later. Eventually,
the circuit
breakers had to
be suspended.
Unfolding at
the same time
as the stock
market turmoil
was the volatility
of the Renminbi’s
exchange
rate, which led
the Chinese
government to intervene
heavily to support the
currency. The dramatic
developments in China’s
stock and currency markets,
compounded with fears over
her economic conditions,
and the Western media’s
sensationalistic coverage of all
these events sent shockwaves
around the world. Together
with Federal Reserve belated
rate hike in Dec 2015, a few
trillion dollars were wiped off
the global stock markets within
the first two weeks of trading.
The US caused the 2008
global financial crisis, from
which the US, Europe and
Japan have yet to recover;
now, it is feared that events
unfolding in China will spark
another global economic crisis
in 2016. What is on investors’
worry lists regarding China’s
economy and how likely are
these worries to become a
nightmare for both Chinese
and global economies ?
First, China’s exports
contracted every month in
2015 except in Feb and
Jun. On 11 Aug 2015, China
announced an adjustment
in the quotation mechanism
of the Renminbi’s central
parity rate. In response, the
Renminbi lost about 3%
against the US$ in 2 days. On
7 Jan 2016, the central parity
rate was fixed at a level that
was the lowest in 4 years.
This immediately stoked fears
that China is weakening the
Renminbi to aid her exports,
which could spark a currency
war. What was not reported in
the media is the fact that until
recently the Renminbi has
been the strongest currency in
the world.
On a related note, it was
revealed that China’s foreign
exchange reserves dropped
to US$3.33 trillion in Dec
2015, the lowest level since
Dec 2012 – see
figure 3
. The
reserves level has been falling
for 13 of the past 15 months,
indicating capital outflow and
the amount China has spent to
support the Renminbi. China
still has the highest reserves
level in the world. However,
with rising US interest rates
and the prevailing expectation
that the Renminbi will remain
on a downtrend due to
slower economic growth, it is
feared that China’s
reserves may not be
sufficient to defend
the Renminbi. What
was also not reported
in the media is the
fact that the Federal
Reserve has been
adopting a zero
interest rate policy
for 8 years. With the
Renminbi tied to the
US$, carry trade in
Renminbi was active
and lucrative. Now the
reverse is happening.
Secondly, on
the list is China’s
high debt level.
After years of high
investment growth, China
has accumulated one of the
highest corporate debt levels
in the world. Given China’s
slowing economy and falling
corporate profits, her corporate
debt level could deteriorate
further. This would, in turn,
heighten the risk of defaults,
bankruptcies, and banking and
economic crises.
Third comes Japan-style
problems. China is
experiencing excess capacity
in her heavy industry as well
as her property sector. With
global commodity prices
plunging, China like many
other countries is facing
deflationary problems at the
producer level. This, coupled
with the high debt level,
reminds people of what Japan
was facing which eventually
led to her losing multiple
decades. What was also
not reported in the media is
the fact that Japan has not
reformed an iota in the last
25 years. The reforms that
China is undertaking in one
5-year plan is more than all
of the reforms that Japan
has attempted in the last 3
decades.
Fourthly, the Chinese
government is losing control.
In the past, the Chinese
government always seemed
to have a firm hold over the
economy. It was generally
able to steer its direction
and manage the pace of
China’s economic expansion.
However, the recent volatility
in China’s stock and currency
markets that occurred
despite heavy government
intervention indicate that it
may be losing its grip over the
economy. It almost seems as
if the Chinese economy is in
deeper trouble than people
think and that there is nothing
the Chinese government can
do about it. What was also
not highlighted correctly in
the Western media is the
unprecedented reform based
on the anti-corruption drive.
The media has incessantly
portrayed president Xi
Jinping’s anti-corruption drive
as a political power grab.
The anti-corruption campaign
has gone on for years and
is conducted at all level and
in all corners of the nation. A
Chinese government losing
control would not be able to
implement this unprecedented
anti-corruption drive, let alone
sustain it for so long.
Given that China is the
second largest economy in
the world, the world’s largest
trading nation, and the
biggest consumer of many
commodities, a hard landing in
China would be catastrophic.
It would drag down many
economies, both developed
and developing. However,
while all of the aforementioned
worries are legitimate, there
are also mitigating factors.
One, short term exchange
rate movements are typically
volatile, in which sentiment
usually plays an overriding role
in determining them. However,
in the longer term, the trend
of an exchange rate always
reflects a country’s economic
fundamentals. After the dust
settles, investors will once
again focus on China’s strong
economic fundamentals,
political stability and huge
potential. Raghuram Rajan,
India’s respected central bank
governor, said in a recent
Bloomberg interview, “My
sense is there is underlying
growth in China ……… It’s not
falling off a cliff.”
Two, China does not
deny that the rapid increase
“The media has incessantly
portrayed president Xi Jinping’s
anti-corruption drive as a
political power grab. The
anti-corruption campaign
has gone on for years and is
conducted at all level and in
all corners of the nation. A
Chinese government losing
control would not be able to
implement this unprecedented
anti-corruption drive, let alone
sustain it for so long.”
China on the move
On 18 Mar 2004,
i
Capital started an exclusive section on China, an
immensely important, huge, and complex nation. As our managing
director described it, the emergence of China is an event that
happens only once in a millennium. Tracking its fast emergence and
understanding its development will be useful not only for investors but
also for businessmen and management. This exclusive series “China
on the move” started with “A Brief History of China”, made up of 8
parts, started with the Xia Dynasty (
夏朝
) and rounded up by examining
Deng’s reforms.
China Today
China today is the world’s most exciting, dynamic, and successful
economy. What drove China’s phenomenal growth in the past few years
? In the previous parts of China Today, we examined her economic
structure, sources of growth, the current conditions, and her future.
Source: Capital Dynamics
High speed train to Nanjing symbolizing China’s
successful economic transformation.
see that China’s Renminbi,
previously tied to the US$,
has been appreciating
for years while the major
competing currencies have
been devaluing precipitously
and there needs to be an
adjustment.
For the Hong Kong stock
market, unfortunately, the
frank and objective opinions
of Rajan do not help. What
i
Capital has been warning
about Hong Kong and the
Hang Seng remain. The
coming recession for Hong
Kong will be prolonged and
the recovery will be weak,
unlike the 2009 V-shaped
FROM PAGE 7
TURN TO PAGE 9
recovery. For the
short-term
,
i
Capital revises its bearish
outlook of the Hong Kong
stock market to a range from
15,000 to 20,000. See Stop
Press for the latest. For the
medium-term
,
i
Capital
retains its bearish outlook
of the Hang Seng Index at a
range from 10,000 to 20,000.
For the
long-term
outlook,
i
Capital will review it at a
later stage but it needs to go
to 15,000 first.
Figure 3 China’s Foreign Exchange Reserves
A
| Market Opinion
8
Capital Dynamics Sdn Bhd
The week of 21 January – 27 January 2016
Volume 27 Number 21