A flock of grey swans

THE global financial markets are experiencing a bloodbath. Over the past few months, a range of financial assets including equities, commodities and currencies of emerging markets have fallen sharply. According to an estimate by Bloomberg, nearly $15 trillion in value has been wiped off from the world's financial markets since their peak. The meltdown on the world's financial markets has quickened pace since the start of 2016. The S&P 500 has fallen 9pc, while the Morgan Stanley Capital International's MSCI Emerging Markets index has plummeted 11pc. The S&P Goldman Sachs Commodity Index ( S&P GSCI), a benchmark index for commodities has declined 13pc, with oil leading the fall in commodity prices with a drop of 25pc from already depressed levels.

Emerging markets have taken the brunt of the battering. According to the Institute of International Finance, capital outflows of nearly $735 billion took place from the world's emerging markets in 2015, with an estimated $676bn from China alone.

Markets have been uneasy over the past year or so. Each data release from the world's second-largest economy China has confirmed the worst - its envelopment in a broad and deep slowdown. Industrial activity, manufacturing output, and China's juggernaut construction and export sectors have all been mired in recessionary conditions. The widely watched manufacturing Purchasing Managers' Index (PMI) from Caixin has been below a reading of 50 (indicating a contraction in output) for 16 months since December 2013.

I have detailed the importance of China to the global economy in a previous article. It is not only the secondbiggest economy in the world, but over the past many years has truly been the main engine of global economic growth. For instance, in 2013, China accounted for 49pc of the expansion in global GDP for the year, versus a contribution of 29pc by the US economy for the year. (For 2012, China's contribution was a full 66pc, or two-thirds).

In terms of imports, China absorbed around $2tr of goods from the rest of the world in 2014, or nearly 12.5pc of global exports excluding China. It is the biggest export market for 43 other countries, ranging from the likes of Australia, to South Korea, Taiwan, South Africa and Brazil. Similarly, it is among the top three export destinations for many other countries, reinforcing the direct firstorder effects on the global marketplace. Since these countries directly affected by China's slowdown are important export destinations on their own for other countries, it amplifies the knock-on effect on the entire world economy.

The slowdown of China's economy and its large knock-on effect on global demand has been reflected in the international commodity markets, principally oil. The 75pc collapse in the price of benchmark Brent crude since July 2014 has as much to do with excess production as with falling demand. Hence, each new fall in the international oil price is further unnerving global investors, as it is underscoring the weak state of the world economy.

Fuel was added to the deepening global gloom by the recent release of China's official GDP growth number for 2015. With a reading of 6.9pc, this was China's slowest economic expansion in 25 years, since 1990 to be precise. From its recent peak of over 14pc growth in 2007, the 2015 growth rate represents a halving of China's annual economic expansion. While the servic- es sector appears to be holding its own, the slowdown in industry, in particular manufacturing, is painfully obvious.

In fact, China's official GDP growth rate has been met with considerable scepticism by external commentators. A wide range of proxy economic indicators - ranging from external trade data, electricity generation, coal imports, steel production, producer prices deflation, reported layoffs in the coal and steel industries etc. - are all pointing to a deeper slowdown than indicated by official data.

The issue of data 'doctoring' by national statistical authorities in developing countries, especially of the GDP growth figure in the context of global competition to attract foreign direct investment, has assumed worrying proportions. While Pakistan has been ahead of the curve and been an early pioneer, its massaging of national statistics has been relatively tame compared to the shenanigans adopted by many other developing countries such as China, Nigeria, Kenya to name a few. Even India's recent changes to its growth accounting methodology have been so opaque, that the forthright governor of the Reserve Bank of India, Raghuram Rajan, has candidly conceded that he cannot figure out his country's true rate of GDP growth based on the new framework.

In the case of China's slowdown, it is worth emphasising that given its size, a growth rate of even 5-6pc a year for China would still add an economy the size of Turkey each year to global GDP. Hence, even a slower-growing China will continue to remain an essential part of the global economy. The sheer size of China and the financial resources at its command are likely to ensure that its economic growth will stabilise at a fairly elevated level in the medium term. While China's economy is unlikely to face a complete meltdown, it nonetheless faces deep structural challenges. One of the most potent, other than the challenge of rebalancing growth, is the huge debt burden carried by corporates, state-owned enterprises, the financial system, and local governments. This is likely to prove to be a major constraining factor in China's early recovery. China is of course not the only ' grey swan' (a milder version of a 'black swan' risk event popularised by Nassim Taleb) confronting the world economy.