As China transitions to a ‘new normal’, some financial, economic and political pain is inevitable

The New Year started not with a bang but a whimper. International Monetary Fund managing director Christine Lagarde’s prognosis at the end of 2015 was that global growth in 2016 would be “disappointing and patchy”, blaming rising US interest rates, the economic slowdown in China, persistent financial fragility in several countries and lower oil and commodity prices.

Sure enough, on the first day of market opening on Monday, January 4, the Shanghai A-share market fell 7 per cent ((and again on Thursday), dragging global stock markets with it. The dominant story in 2015 was the slowdown of the Chinese economy and its impact on global commodity prices, including demand on luxury goods. Will this trend continue into 2016?

There are good reasons for being cautious. The foreign media’s analyses of the Chinese economy are almost uniformly pessimistic. Not only do they think there will be a hard landing, but several analysts think a financial crash is inevitable.

READ MORE: A trillion-dollar question on China’s forex dilemma: just how low should its reserves go?

The facts are quite clear on the risks. First, from 2008 to 2014, China’s private debt-to-GDP ratio rose by 73 percentage points. The famous 2009 book by Carmen Reinhart and Kenneth Rogoff, This Time is Different, suggested that fast-rising private debt is the best indicator of financial crises. In the past five years, Chinese debt has grown fastest in terms of total debt. Second, the economy is clearly slowing, with both manufacturing and service-sector indicators being negative or showing a slowdown. Third, since last July, despite market intervention, the stock market index is still signalling downwards. Bank of America Merrill Lynch analysts are predicting a Shanghai Composite Index level of 2,600 for 2016, compared with a peak of 5,178 last June and current levels of 3,100. Fourth, there are capital outflows and concerns on renminbi depreciation.