Events in Greece and China test investors’ faith
RECENT developments in Europe and China pose important questions for investors. They test two widely held faiths: the first is the ‘whatever it takes’ commitment to the euro among Europe’s leaders; the second is the ability of the Chinese authorities to control their economic destiny.
Through the crises of recent years, investors have comforted themselves with these two beliefs, but the Greek bailout negotiations and China’s heavy-handed efforts to stabilise the stock market give pause to reconsider these beliefs.
Greece in debtor’s jail?
It went to the wire, but one might conclude the current phase of the Greek crisis is over – after all, a 7bn (R97bn) bridging loan has been made ahead of a longer term deal to be negotiated over the coming weeks. Expectations are that the Greek government will comply with the conditions required to enter negotiations and that a three-year European Stability Mechanism (ESM) financing deal will be signed in August. If all goes to plan, a ‘Grexit’ risk should be off the table.
But to think Greece is out of the woods would be wrong. The situation remains fragile. Prime Minister Alexis Tsipras will support a deal he objects to only because the alternative of leaving the euro seems too awful to contemplate. His party, Syriza, has fractured, with a significant number of its MPs opposed to the creditors’ terms. Curiously, therefore, the prime minister is reliant on opposition support to obtain the three-year bailout.
The sustainability of any bailout deal appears dubious, not only because of a lack of political commitment but also the likely impact further austerity will have on the Greek economy. The proposed deal will place heavy emphasis on structural reforms, some of which will be welcome; but one conclusion to the failed austerity of recent years appears to be that there was not enough austerity.
Most likely, it seems, the Greek economy will remain locked in depression, imprisoned in the policies dictated by Germany-led Europe with regular visits from the wardens, that is the Troika (European Commission/European Central Bank (ECB)/International Monetary Fund). It is unclear how long Greeks will put up with this.
First, while fair to argue the creditors’ stance might reflect a democratic balance of opinion at a Europe-wide level, developments have sharpened national divides along creditor-debtor lines.
Second, debtor nations have lost national sovereignty, as the Greek referendum illustrated – the deal on the table was publically rejected, only for the prime minister (who had campaigned ‘No’) to sign up to something as tough a week later.
Third, we have learned that commitment to the euro is not absolute. ‘Whatever it takes’ might not apply. The hard line attitude of certain creditor governments was predictable, but German Finance Minister Wolfgang Schaeuble’s public desire to force a ‘Grexit’ was remarkable.
Fourth, the euro area does not have a proper lender of last resort, as Greek depositors will testify. The ECB’s refusal to provide additional liquidity to banks, which were deemed solvent at its own comprehensive assessment less than a year ago, is another twist in this sorry farce. Rather than act as lender of last resort, the ECB has played the role of European enforcer.
The above observations illustrate the fragilities inherent to the wider euro project. The uncompromising stance of the creditors with insufficient focus on stimulating growth and (so far) remarkable intransigence on debt relief (an inevitability one way or another) has hardened nationalist sentiment, widened the creditor-debtor divide and once again called into question the long-term viability of the euro area.
As Martin Wolf of the Financial Times puts it, the Greek people elected a “dreadful government produced by desperate times”. But the creditor nations have played a risky game. By adopting a tough, imposing stance with Greece, they hope to present a credible threat to any other recalcitrant governments. The danger is they have made the euro project a much less appealing idea and opened Pandora’s box by hinting at its reversibility.
The ‘visible hand’ of China
The sharp decline in China’s equity market (after a colossal rally) has provoked widespread attention, not least among the nation’s policymakers.
In a dramatic turn of events, Chinese authorities unleashed a number of measures to stem the stock market’s decline. The government didn’t intervene so blatantly last year, yet has deemed it necessary to do so now after the recent retracement.
In late June/early July, the authorities cut interest rates, increased liquidity provisions, loosened margin requirements, supported a market stabilisation fund, instructed direct government investment, halted initial public offerings and banned major shareholders from selling shares.
These are extraordinary steps for any government to take, yet alone one that is espousing a shift to a more market-based economy. Having effectively sponsored a bull run in the equity market starting last year, recent actions expose just how concerned the Chinese authorities are about a negative financial spiral.
The heavy-handed government response may indicate how difficult it might be for China to transition its economy. If nothing else, it does not make for a healthy stock market. Some may rationalise events as of limited significance. The big risk is if recent action shakes confidence in the ability of the Chinese authorities to determine their fate. Most investors have maintained faith in the Chinese authorities to pull off a gradual economic slowdown, while transitioning the economy to a more sustainable footing in the long term.
We share this view. We believe easing measures over the past year will help support a stabilisation in near-term growth in China, although we expect a prolonged slowing in the future growth outlook. Together with the implementation of various reforms, we expect monetary and fiscal easing will avert a hard landing.
At the same time, we do not assume the authorities will pull all the right levers. We are, therefore, watching developments closely, and reassess our views regularly with regard to the short- and long-run outlook for the Chinese economy.
The Greek bailout talks and China’s efforts to stabilise the stock market turn two long-held beliefs upside down.
Tristan Hanson is the head of asset allocation at Ashburton Investments