Over the past years, global economic growth has been highly conditioned by China’s contribution.
China’s sustained high single digit growth figures were the direct result of the efforts of China overflowing its financial system with easy credit, which led to a property and construction boom and an increase in demand for commodities and imports.
As a consequence of globalisation, China has been accountable for approximately 30 per cent of the global economic growth post the financial crisis - a bang in China is a bang for the rest of the world's economies as well. That being said, a slowdown in China over the past years has emerged as a dragger and going forward growth in the second largest economy, China, is predicted to remain slow which will be a gust for the rest of the world's economies as well.
Understanding China’s current situation means first understanding what has happened in the years that led up to such situation. Near-end 2012, Xi Jinping became the new leader of China. In all respects, Xi has been an intelligent leader who understands the issues facing China and has shown genuine concern to improve his country, but his succession did not come easy.
After economic liberalisation in China and growth rates in the rest of the world slowing down sharply, the Chinese economy was in need of reform. Xi’s predecessor utilised monetary expansion and soaring asset prices as means to promote a sense of well-being for Chinese citizens, rather than accepting lower growth rates and aggressively imposing longer-term economic reforms.
Xi Jinping was also faced with the issue of corruption and disloyalty by party members, thus experiencing first-hand how an absence of strong national leadership would affect the execution of party directives.
For this reason, he chose to continue on the path of an excessively loose monetary policy which gave way to massive growth in mortgage lending.
This had a very real impact on the political capital of China, as property now comprises an estimated 70 per cent of Chinese household net worth and as a result, Chinese citizens are extremely sensitive to fluctuations in property values. In addition to, China has gone a step further by actually directly buying surplus housing inventory to prop up its housing market.
Should China continue to neglect economic reforms and keep pumping money into its financial system, data points are indicating that in 2019 this will all backfire.
After a period of enhancing liquidity to heighten economic sentiment, China is once again aiming to reduce the moral hazard in its financial system and deflate asset bubbles in property. When China did this in the past, there were significant impacts on financial markets around the world.
This tightening of credit in China will have a very real impact on asset prices around the world in the coming 18 months.
It is already evidently impacting China’s property sector as can be seen with trends in real estate sales figures.
As another data point around the health of China's property sector, one should look at equities and bonds of China's largest property developers, bond yields are rising and equities are in free-fall. Clearly, investors are taking note of how sensitive the property boom is reflecting in the markets.
Commodities is another asset class that is highly sensitive to these trends in liquidity. China consumes a disproportionate amount of the world's commodities relative to its size thus, any slowdown in credit in China has a deflationary effect on commodities.
Another key factor dampening China’s economy are the recently placed tariffs due to the Trade War with the US; the Chinese currency being negatively impacted. A weakening yuan means the limitation of China’s monetary tool to stimulate its economy, when the necessary monetary adjustments are required. The talks of tariffs alone have spurred a sell-off in the yuan. As interest rates rise in the rest of the world, China will run into trouble stimulating its economy with easy credit and lower interest rates, thus putting even more pressure on the yuan.
In 2017, the People’s Bank of China had tightened the monetary policy and new regulation was set into place. Bond yields were on the rise and an inverted yield curve was seen. Gradually, the situation recovered but is it possible for another inversion to occur? China is once again considering tightening credit which would lead to less demand and hence, even more of a slowdown within China’s economy. To add insult to injury, commodity prices falling, the property market being impacted negatively and now the trade war leading to a falling currency, the overall economic situation seems to imply that an inversion of the yield curve seems inevitable in 2019.
Are there solutions? The first option could be to further stimulate its economy by providing support to a property bubble and let the rest of the world raise interest rates. However, this would lead the yuan to plummet in value and the economy would eventually enter a period of short-term economic crisis. The second option is to continue to tighten credit and enter a period of short-term economic setback.
Either way we will see a period of lower growth in China, which will have a very real impact on financial markets.
Disclaimer:
This article was issued by Maria Fenech, investment management support officer at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.