China can’t be passive and shortsighted if it wants to get out of a bear market

  • Hao Zhou says the outlook for the Chinese economy is weak, as consumption falls and the deleveraging campaign stalls. Chinese policymakers need to come up with longer-term solutions and convince the market of China’s commitment to economic openness
PUBLISHED : Thursday, 01 November, 2018, 10:01am
UPDATED : Thursday, 01 November, 2018, 10:04am

What a difference a year makes. Around this time last year, one of the most frequently asked questions about China’s economy was: is it in a new boom cycle? The optimism about the Chinese economy was largely driven by the consumption story. By this logic, rising consumption would not only help China sail through structural challenges, but also rebalance the global economy and boost the financial markets.

However, the market has to admit that it might have been too naive and underestimated the challenges facing China. What has really surprised the market is China’s extremely poor consumption figures this year, which have raised concerns about the soundness of China’s domestic demand. For instance, passenger car sales barely grew in the first three quarters of this year, the weakest performance in about a decade. Amid the gloom about China’s demand and the uncertainties from trade tensions, global automobile producers need to think twice before they allocate more investment for China.

In the meantime, China’s deleveraging campaign appears to have stalled, fuelling worries about medium-term growth prospects. According to recent data from the Bank for International Settlements, China’s non-financial corporate debt as a percentage of gross domestic product has ticked up again since the beginning of this year. This is after a mild decline through 2016 and 2017, suggesting that the government is putting aside China’s debt problems and shifting its focus to supporting growth.

This does reflect the strong political will to meet the growth target for this year. However, while few economists would project a significant deceleration in China’s growth in the coming quarters, the medium-term outlook has actually become more challenging due to the debt overhang.

Is China’s war on debt targeting the right enemy?

Subdued consumption and delayed deleveraging, to a large extent, have disappointed investors, especially equity experts who are looking for medium-term investment opportunities. As a result, China’s stock market has gone into free fall, with the benchmark CSI 300 index sliding about 23 per cent year to date.

Notably, there has been concern about share pledge financing mostly held by commercial banks. While there is limited public information about the volume and tenor of such innovative lending options, Chinese securities regulators struck a note of caution as they rolled out measures to allay fears that the banks would click the “stop loss” button on shares used as collateral for the loans, and trigger further declines in the market. However, it would not be easy to persuade investors to buy such shares anyway. Basically, the market is reflecting the weak economic outlook and a liquidity crunch.

The bearishness has spread to the foreign exchange market too. China’s yuan is now trading at its weakest level since the global financial crisis 10 years ago. While the market keeps an eye on the hurdle of 7 yuan per US dollar, the consensus is that the renminbi is under pressure to weaken further due to soft economic fundamentals and the trade dispute.

Although the People’s Bank of China may have to defend the psychologically important level of 7 yuan per dollar to prevent a further market meltdown, such a passive form of defence would hardly rejuvenate the market.

How China can save the WTO, and itself

Ultimately, it is hard to dispel the bearishness with short-term solutions. The Chinese authorities should know that far better than the market. The success of China’s economy is mostly about evolution and engagement in the global system. Therefore, it makes sense for China to adapt to changes in the global environment, and not vice versa, even though China is the world’s second-biggest economy.

From this perspective, China needs to improve its policymaking and communication to enhance mutual understanding with other economies. As such, Chinese policymakers should take action in key areas to convince the market of China’s continuous openness and sustainable growth.

In particular, China needs to facilitate market access for foreign companies, improve intellectual property protection and streamline its regulatory framework. Domestically, the government needs to take decisive steps to reduce tax and cost burdens especially for privately owned companies, which is crucial to enhancing productivity and boosting domestic demand. Put simply, China should take a more active approach to addressing its own issues.

Hao Zhou is senior emerging markets economist at Commerzbank