China slow­down is no cause for global alarm

The Pak Banker - - OPINION - Is­mail Er­turk

THE year started with an ini­tially alarm­ing tur­moil in stock mar­kets around the world. The Chi­nese stock mar­ket and the off­shore Chi­nese cur­rency mar­ket in Hong Kong were the twin epi­cen­tres of this fi­nan­cial scare. Al­though the slow­down of the Chi­nese econ­omy is a pop­u­lar ex­pla­na­tion by most mar­ket com­men­ta­tors for the wild fluc­tu­a­tions in fi­nan­cial mar­kets, I do not think that it is a con­vinc­ing one. Firstly, the Chi­nese slow­down was not un­ex­pected. Al­though the lat­est reg­is­tered Chi­nese GDP growth is slightly lower than the av­er­age 7 per cent that China had an­nounced as new nor­mal a cou­ple of years ago, it is still much higher than any ma­jor econ­omy in the world, ex­cept In­dia's. Also, firms like Gen­eral Mo­tors an­nounced that they achieved record sales fig­ures in China in 2015. What ex­plains the tur­moil in Chi­nese stock and cur­rency mar­kets, I be­lieve, is due to a cor­rec­tion that is re­lated to the three ex­per­i­ments with the fi­nan­cial mar­kets.

In the first, the Chi­nese govern­ment en­cour­aged, for political and eco­nomic pur­poses, lever­aged retail in­vest­ment in stock mar­kets caus­ing a huge bub­ble, es­pe­cially in 2015. The se­cond saw Chi­nese retail in­vestors trust their govern­ment rather than their an­a­lyt­i­cal ca­pa­bil­i­ties to search for yield in the stock mar­kets, whereas the au­thor­i­ties have so far failed to cre­ate new le­git­i­mate as­set classes - both do­mes­tic and in­ter­na­tional. A third on sta­te­owned and pri­vate cor­po­ra­tions' bet on the con­tin­u­ous rise in the yuan's value against the dol­lar amidst low dol­lar in­ter­est rates. All three sec­tors in the Chi­nese econ­omy are - the­o­ret­i­cally and prac­ti­cally - un­der-de­vel­oped in fi­nan­cial cal­cu­la­tions. The Chi­nese eco­nomic de­vel­op­ment has so far pri­ori­tised the real econ­omy by mak­ing fi­nance serve it through a cen­trally planned bank­ing sys­tem and stock mar­ket. The chal­lenge now for au­thor­i­ties is to de­velop a fi­nan­cial sys­tem that suits an in­ter­na­tion­al­is­ing China with a grow­ing ser­vices sec­tor. And the chal­lenge for the rest of the world is not to turn this Chi­nese search for a fi­nan­cial bal­ance into a desta­bil­is­ing spec­u­la­tion for the likes of hedge funds.

An or­derly in­ter­na­tion­al­is­ing Chi­nese econ­omy and fi­nan­cial mar­kets and cur­rency are in the in­ter­est of the whole global econ­omy. Chi­nese do­mes­tic stock mar­kets are not di­rectly open to in­ter­na­tional in­vest­ment. Chi­nese com­pa­nies do not bor­row from in­ter­na­tional banks and there­fore there is no con­ta­gion risk to the rest of the world from China's teething prob­lems in fi­nance. I be­lieve the sharp de­clines in the stock mar­kets in the US and Europe were due to the grim eco­nomic out­look for those economies. So the blame for the tur­moil in the early days of 2016 should rest with the pol­i­cy­mak­ers and pri­vate sec­tor in the US, where the low oil price has ex­posed its en­ergy sec­tor and banks to new credit risks. In the EU, Ital­ian banks es­pe­cially have large amounts of bad debt that thwart the ECB's quan­ti­ta­tive eas­ing poli­cies. With the end of credit ex­pan­sion in China and mon­e­tary loos­en­ing in the US, the global econ­omy has en­tered into an un­pre­dictable pe­riod. The im­me­di­ate fo­cus is go­ing to be whether China is go­ing to be a new source of in­sta­bil­ity for global fi­nan­cial mar­kets and whether it can con­trol its mon­e­tary poli­cies and its cur­rency, which has just been in­cluded in the IMF's spe­cial draw­ing rights. The very first step that China has to take is to in­sti­tu­tion­alise a cen­tral bank that global play­ers be­lieve is in­de­pen­dent of political in­ter­fer­ence. Such a cen­tral bank re­quires a gov­er­nor who is a house­hold name for the rest of the world and has ex­cel­lent com­mu­nica­tive skills with the mar­kets. China, how­ever, should not fall into the trap of a cen­tral bank-led econ­omy like the US and Eu­ro­zone af­ter the 2007 cri­sis. Cre­at­ing a ser­vice econ­omy at home and in­ter­na­tion­al­is­ing Chi­nese fi­nance is not a mon­e­tary mat­ter. An ex­is­ten­tial prob­lem faces China - how to tame fi­nance to serve its real econ­omy at home and abroad. The Western fi­nan­cial sys­tem that China has far copied is not the right an­swer. In­stead of see­ing China as a threat to global fi­nan­cial sta­bil­ity, the world should col­lec­tively use China's in­ter­na­tion­al­i­sa­tion as an op­por­tu­nity to build a safer global fi­nan­cial sys­tem for all.

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