A flock of grey swans

The Pak Banker - - 4EDITORIAL - Sakib Sherani

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.

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