Chinese equity markets took another beating this week with the Shanghai composite down 12% on the week. This took the index back its early July low, erasing the full impact of the earlier policy measures aimed at supporting the market. This leaves the index down 32% from its mid-June high, though still 57% higher than one year ago. To be clear, the Chinese equity market had already fully decoupled from the real economy for some time: just as the 155% increase in equity markets in the year up to last June wasn’t a reflection of massive economic strength, the current fall in the market is not a sign of total economic collapse. Still, the Chinese economy is not in great shape.
The Chinese economy has been slowing down for years now. From a spectacular 14% in 2007, economic growth is now falling below 7%. And China will continue to slow down in coming years. This is unavoidable as the economy shifts from its focus on exports and debt-driven investment spending to more consumer-led growth. In the longer run the aim is to reach a more sustainable growth model. And in this context, more sustainable growth also means lower growth. The key question is whether this transition will happen gradually, or rather that the slowdown will get out of hand at some point. Up to quite recently, the Chinese authorities seemed to be succeeding fairly well in managing the slowdown. However, their recent moves have raised concerns about whether or not they are losing control. Especially, their remarkable moves to first boost the equity market and then to prevent it from correcting was quite ill-advised (see also our opinion in De Tijd (only in Dutch): De eerste barsten in het Chinese beleid). While it is possible to direct economic activity, as the Chinese authorities have been doing for years, it is a whole lot harder to control financial markets.
In the next few months, the Chinese authorities are likely to shift back to more conventional stimulus measures to control the slowdown of the economy. And they still seem likely to succeed in doing so. That said, the continuing slowdown of the Chinese economy, even if it is managed successfully, has important implications for global financial markets. Given the central role of China in commodity markets, its slowdown will keep a lid on commodity prices for quite some time. Moreover, the current state of the Chinese economy warrants a further weakening of its currency. This is also likely to keep global monetary policy more supportive for longer. Finally, China’s wobbles will continue to impact global equity markets. On the back of renewed stimulus efforts, the next move on market sentiment is likely to be more positive than this Summer’s wave of disappointing news.