150921 10 urgent questions

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Group Economics Emerging Markets

China Watch

Arjen van Dijkhuizen +31 20 628 8052,

Ten urgent questions

21 September 2015 •

The way the authorities handled the stock market rout and communicated the change in the exchange rate regime seem to have raised doubts about their capability to manage macroeconomic and financial stability risks.

We have cut our economic growth forecast for 2016 from 7% to 6.5%.

This assumes that China’s economy will continue a gradual slowdown, as the authorities remain willing and able to add stimulus while services and consumption hold up better than industry and investment.

However, China faces several major macro-financial risks, which if not managed well could trigger a hard(er) landing.

In this report, we give some background on China’s growth story and risks by posing and answering ten key questions.

1. Why are markets so concerned about China? Over the past months, global financial markets have become more concerned about China’s outlook. China’s sharp stock market correction in June-August, the unexpected change in the exchange rate regime mid-August, the sharp drop in commodity prices and weak macro economic data all have contributed to rising fears that the economy is doing worse than official (GDP) figures suggest. Weak liquidity in global financial markets in August and the looming Fed rate hike also look to have added to market volatility as well. In our view, the concerns regarding China are understandable, although we think that over the past few months market perceptions regarding China seem to have changed more than China itself. Given China’s sheer size and its intransparency, negative developments surrounding China always have the potential to cause market jitters, certainly if these come unexpectedly. At the same time, downside risks to the Chinese economy are certainly not new (see below). Moreover, China’s economy has lost momentum in the course of this year, but macro economic data are still pointing to a gradual slowdown. All in all, the way the authorities handled the stock market rout and communicated the change in the exchange rate regime seem to have raised doubts about their capability to manage macroeconomic and financial stability risks.

published on 5 August). For instance, banks were instructed to provide lending, alongside the PBoC, to the national marging trading provider (CSF). The severe policy reaction shows that the government is prepared to launch short-term stabilisation measures, even if that might hurt longer-term goals. Still, the measures have raised questions on the government’s commitment to financial liberalisation. The developments also illustrate the need to improve the governance of the equity markets. Meanwhile, the stock market correction adds downside risks to the economy (confidence effects, lower contribution financial services to growth), but overall (wealth) effects look relatively contained.

Stock market rout SSE index, A shares

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2. What does the stock market correction tell us? After having more than doubled since October 2013, Chinese stock markets lost some 40-45% since mid-June, although with some stabilisation in recent weeks. The sharp correction partly comes from concerns on China’s slowdown, but has been magnified by the tightening of margin requirements and the closing of leveraged positions. The correction should be placed into some perspective. The extreme rally over the past year, partly driven by supportive policies and the increased use of margin lending, was not in line with fundamentals and looked unsustainable. In that sense, the correction is even welcome to a certain extent. The authorities have rolled out a wide range of measures in reaction to the stock market rout (see our China Watch

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Source: Thomson Reuters Datastream

3. Did the change in the CNY regime make sense? Yes, but communication could have been better. The authorities wanted to show commitment to incorporate more market elements into the CNY regime, in the run-up to the IMF’s decision on SDR inclusion (which has been delayed to 2016). What is more, pegging the currency to a strong USD was hurting China’s external competitiveness. Some currency depreciation will not only help to restore competitiveness somewhat, but can also help pushing Chinese inflation a bit higher. Although we expect some more moderate CNY weakening in 2015 and 2016, we do not think that the yuan


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