The Chinese economy is in turmoil.
The crisis of the stock market is showing no sign of recovery despite a series of measures by Chinese policymakers. Chinese policymakers started with increasing the money supply. When that could not prevent selloff at the stock market, the next move was to apply circuit breakers on the stock market. And when the decline persisted the next move was to devalue the currency. The devaluation of the Chinese currency is considered a radical move by many, predicting it to have far-reaching consequences for the global economy. Some believe the move is aimed at deregulating the foreign exchange regime in China to make it more reflective of the market economy. Many fear this devaluation will boost Chinese exports and curtail imports, thus giving a boost to the trade surplus in the long run. The move will also serve as a boost for companies focused on exports, which in the case of China is a very large segment of commerce. Many fear that this move by the Chinese authorities may precipitate a global currency war that may put pressure on currencies across the globe.
In the aftermath of emerging troubles within the Chinese economy, the US dollar is strengthening further while emerging market currencies are facing pressure, some observing record declines against the US dollar. The rot in emerging market currencies, though all linked to China, is for a multitude of reasons. For one, in countries relying heavily on commodity exports, a slowdown in the Chinese economy signals a squeeze on demand, which will adversely affect the commodity exporters’ balance of payment. For other emerging economies, particularly in East Asia, the decline is caused by the emerging centrality of China in regional as well as global economies. For instance, many South East and East Asian countries rely heavily on exports to China; a slowdown in the Chinese economy and a weakening Chinese renminbi means it will hamper exports. And then there are many economies that rely on Chinese investment to grow. The Chinese economic crisis has far-reaching impacts for the global economy and many experts are predicting that this may precipitate a global financial crisis that may be bigger in magnitude than 2008’s financial crisis.
Just when it is very difficult to predict the course the Chinese economy will take from here and, in the aftermath, how the global economy will react, there are a few things on which a consensus is emerging. In all likelihood, because of the ample reserves’ buffer accumulated over the years, the Chinese economy can stomach the blow. The bigger question is how strong the blow will be. Because of the close and controlled nature of the Chinese economy, for now it is unclear what the debt exposure of corporates and the real estate sector is and how much of it is forex denominated. This will determine the extent of drain on reserves. Another thing that seems certain is that commodity prices, including of oil, are to stay depressed for the foreseeable future.
As for Chinese investments overseas, the biggest impact will be on economies where the investments were aimed at exploring and transporting commodities. China still has deep pockets and will accelerate investment in markets with the potential for exporting Chinese goods and services. Lastly, because of a sluggish economy and uncertainties, capital flight in the form of private investments will take place to developed economies with higher standards of living. Australia and New Zealand seem to be the biggest targets for such capital flight.
The depreciation of the Chinese currency may also make the Federal Reserve of the US rethink its plans to increase interest rates. This may provide some liquidity in the US market, which may ultimately precipitate demand for Chinese exports. However, as has been evident since 2008, the enhanced money supply has not translated at the same pace of expansion in credit supply within and outside the US. Also, another concern for the Federal Reserve will be the fear of a bubble forming in the bond market. So, the Federal Reserve may not be able to hold on to lower interest rates for long. However, even if the Federal Reserve holds interest rates at the current near-zero level, this most likely will not be enough to boost the global economy.
Where does this leave Pakistan? The devaluation of the Chinese currency has put considerable pressure on developing economies’ currencies with the US dollar strengthening on account of being the safe currency. This coupled with the fact that the country has tried to maintain a forex rate that is artificially high poses the serious risk of a major currency decline in the months ahead. This together with the fact that in the last two years a lot of dollar denominated borrowing has been conducted and that forex denominated commitments have been made for infrastructure and power projects, a serious risk for the economy and currency is posed. Both monetary and fiscal policymakers will have to take stock of the situation and preempt measures to improve the balance of payment outlook for the coming months.With the global economic crisis looming, the economy will suffer big time.
The author can be reached on twitter at @aalimalik