Fears about China have spiked in recent weeks. What factors are driving these concerns and how significant are they?
To begin with, China’s economy is difficult to understand. The government often is opaque in its communications and changes rules quite regularly. This makes it harder to understand the future direction of the country and can exacerbate fears.
The government’s approach to recent losses in the Chinese stock market is a good example of how fickle rule making has unnerved investors. Last week, the government tried to stabilize the Chinese market by introducing a rule shuttering trading after a 7% drop. But just three days later the rule was cancelled after it was set off twice. This about face undermines credibility.
Credibility with the average Chinese investor is important because retail Chinese investors place most of the daily trades in China, even though they only own about 20% of the shares. In contrast, in the U.S. and other developed markets, sophisticated investors are key drivers of daily price movements. Accordingly, the volatility in the Chinese markets gives you a sense of Chinese psychology and confidence in the government, but does not indicate much about the health of the Chinese economy.
The Chinese renminbi currency is in the midst of several significant changes and the market is still adjusting to these moves. In August, the government abandoned its peg to the U.S. dollar. In November, the IMF accepted the renminbi into its group of reserve currencies. Last month, the Chinese government debuted a new basket of currencies and said they would monitor the movements of the renminbi versus this basket, not the dollar. The renminbi has depreciated as these changes have occurred and speculation is that the renminbi could fall another 5-10% versus the dollar. If that occurs, other emerging market currencies might weaken as well, making emerging market debt in dollars more expensive for countries and companies to pay off. This in turn could pose problems for emerging market stocks.
The pace of currency movements is also important, as a rapid change could undermine stability. China has more foreign currency reserves than any other country and has been using some of these reserves to keep the renminbi from dropping too quickly. Some market watchers worry that China is using its reserves too rapidly, but with over $2 trillion more reserves than any other country, it has plenty of leeway to use these reserves if needed.
Official Chinese 2016 GDP growth is predicted to be 6.8%. While 5%-6% growth is more likely, this still represents substantial growth, especially as the country continues to transition from a manufacturing focus to a more consumer led economy. If growth drops further, the government will likely institute new measures to stir the economy.
Bottom Line: While the Chinese economy is certainly in flux and has some worrying trends, the country has various tools available to soften economic weakness and help it pick up steam over time. It will be very important to see how well the government implements any new policies to bolster the economy.
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