Is the Chinese stock market crash a threat to the global economy?

Is the Chinese stock market crash a threat to the global economy?

China has just allowed the biggest fall in Yuan in 5 months on 7th January 2016 which will go down in history as a time of pressurizing of regional currencies and tumbling of international markets.

Can the fall of the Asian giant lead to widespread panic and impact on the global economy? China’s stock markets were suspended for a day less than half an hour agate a new circuit breaking mechanism failed to pull through for the second time. PBOC set the official midpoint rate on the yuan 0.5 percent weaker at 6.5 per dollar. This is the lowest value since March 2011. The tracked losses were the biggest daily fall since August 2015 when a near 2% devaluation of the Chinese currency also rattled the markets. Central bank’s actions have driven the Yuan down not against the dollar alone. Other major currencies have also seen a change.

Yuan has a 3.5 percent fall against the Japanese Yen and 0.8% against the euro. Concerns are high China may be aiming for competitive devaluation to help exporters. This zero sum game as currencies weaken in response can end in greater volatility.

Right now, what is plaguing the markets is the fear of the unknown. Let us conquer it by examining if the Asian giant’s stock market crash will really hurt the world economy.

Yes

1. Fear of unknown is a massive risk - This is the largest risk for the yuan in the near term. This is so despite the massive current account surplus that China has. Australian dollar used by forex dealers as liquid proxy for yuan fell more than half a US cent. Koreans are on a slightly better boat with almost all of the initial falls with banks recovered.

2. Declining reserves - Data on 7th January 2016 showed that China’s forex reserves fell by the most on record within the last month down USD 108 billion in December 2015. Accelerating outflow of money from China could be a sign of opening up of its financial markets, but it could also signal the world’s 2nd largest economy is in a jam.

3. Yuan puts pressure on emerging Asian economies - A sustained depreciation in the yuan forces Asian currencies to become weaker to stay competitive. China’s massive export machine is daunting prospect to compete with.

4. Equities markets worldwide impacted -Shanghai stocks slid 7.3% to trigger a half in trading while the Japan Nikkei shed 2.3 percent in sympathy and the Hang Seng fell down by 2.8%. Hat mechanism intended to cool market volatility has hotness it up instead.

5. China is a key market - Therefore, the slowdown could cause consumers and companies to buy fewer goods from foreign shores. There is also scepticism about accuracy of China’s official government data which could be understating the growth. People are not believing the official data causing stock market volatility

6. Skewed Chinese economy - This is seen by some as legacy of the state planning model which did not give importance to services. China’s economy has lost out on double digit annual growth rate as it has been driven by massive rise in debt and increased expansion of industrial and real estate sectors as country expanded. To help pay up for the expansions the Asian giant increased its borrowings. A report from McKinsey Global Institute has found nation’s overall debt has quadrupled to USD 28 trillion from 2007 to 2014. While the debt is manageable, it is not easy to handle as the ratio of debt to economic output is larger than US or EU nations.

7. Debt of local governments is unsustainable - This adds to the obstacles for the Chinese economy and that of the world. China needs to be less dependent on exports and more so on internal consumption. This is not happening. Policy adjustments are needed or China (and the world’s) growth will be impacted. China is moving to market based exchange rate policy from strict government control. Devaluation of currency could be used to boost the economy and this in turn makes goods cheaper for international markets, thereby influencing other markets across the globe.

No

1. Slowdown is managed properly -The slowdown has been managed well and it is impacting the top line of numerous firms.

2. China’s economy is too large - Given the size of China’s economy, it is thought the Asian giant will continue to deliver growth and concerns are ripe about being able to access this growth.

3. Market access limits are not permanent - Foreign companies will eventually gain entry into the Asian economy and benefit considerably from this.

4. China’s stock market has nothing to do with its economy - The stock market crash is dominated by small savers who have more faith in speculative investing than fundamental analysis. While many countries see the stock market as the leading barometer of economic health, this may not hold true for China, and consequently global implications for the world.

5. Slowdown in growth is not unexpected - Experts had known that the Chinese economy would slow down as the nation initiated reforms designed to generate growth and transition to an economy fuelled by consumer spending. Economists expect a growth of 6.8% in 2015 and 6.5% in 2016 as against the regular 10% GDP growth on a regular basis. But employment levels are as important and will be maintained on the strength of reforms.

6. Slowdown is not so severe - Chinese economy will still grow at 6.5% and that is still plenty of momentum for the global world economy.

Conclusion

China’s slowdown will definitely impact the world economy, but there could be positive repercussions to this as well. Excessive reliance on the strength of the Asian giant can prove disastrous for world powers and some amount of self-sufficiency is needed for economies to truly grow, develop and prosper. Even if the Chinese market does impact the world economy in adverse ways. India remains a bright spot in a gloomy outlook, according to IMF Chief Chrstine Legrand. What is China’s loss could be India’s gain!