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Why China doesn’t pose a threat to the global economy right now

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Written by: Paloma Kubiak
22/01/2016
China's economic growth was the slowest in 25 years in 2015, growing by 6.9% last year in comparison with 7.3% the previous year.

As China’s stock markets continue their rocky path, investors will be naturally nervous about the impact this will have on global economies.

For Stephanie Flanders, chief market strategist for UK and Europe at JP Morgan Asset Management, the issues in China do not pose a threat to the global economy, irrespective of the latest growth figures.

But why do we even care about China’s stock market? It’s all to do with how connected assets are and how exposed we are to them, says Flanders. Put simply, China matters to the UK and global economy because many listed companies, including many on the UK’s FTSE generate their revenue from outside of the UK.

According to data from JP Morgan, the companies that make up the FTSE 100 obtain only around 20% of their revenue from the UK economy, meaning the index has a global rather than domestic focus.

Taking this into consideration, Flanders says there are three relevant questions investors and speculators should be asking about China.

  • Is China facing a serious problem?

There’s no doubt that China’s facing problems, but it isn’t a serious problem according to JP Morgan as China’s still a relatively closed economy.

Growth is slowing, China used the circuit breaker tool twice in the first trading week of 2016 and the equity market has been impacted by the Chinese renminbi hitting fresh lows.

But the renminbi has increased in real terms in the last few years – it’s about 30% higher than it was in 2006, compared with 10% for the US dollar. It seemed that as the western economies recovered from the financial crisis, China took on the strain of the exchange.

Since the start of the year, there has been some depreciation of the renminbi as the Chinese government looks to make it a more global currency so it’s not just valued against the US dollar but against a basket of currencies to achieve a more free market rate and to make exports more competitive.

But Flanders says China wants the renminbi to be respected and it also doesn’t want to rock the boat for companies which may have borrowed in dollars as they’d be a lot worse off so the speed of devaluation is key.

A steady and gradual depreciation trend against the benchmark US dollar is much needed to prevent excessive appreciation of the currency in trade-weighted terms and JP Morgan believes a weaker renminbi can help ease monetary conditions and the debt burden for Chinese corporates.

  • Does China have the capacity to deal with the issue?

In spite of the currency and debt problems, Flanders believes China does have the capacity to do what western economies did in 2009 to socialise private debt.

As an emerging market, China’s debt as a share of GDP is similar to other developed economies. In fact, it’s not far off where the eurozone is now.

China has very low household debt and public debt as a share of GDP, so it can afford to absorb these losses in the financial system. But there is a loss of confidence in China in light of how fast the value of the currency has been falling.

  • What are the chances of China’s economic problems impacting the rest of the world?

China is still a relatively closed economy but it does not mean we can be relaxed about it, says Flanders. If it were to lose complete control of the currency, it would be a serious issue for emerging markets which could trigger problems for the global financial system.

However it depends exactly how much we care about it as on paper, the problems do not seem strong enough to pose a threat to recovery or the economy right now.

Flanders says that consumers in the developed market are carrying the global recovery and in the UK, households are more confident since the recession, borrowing more so consumption growth has been maintained.

She asks: “If the world were to end now, where is the recession going to come from?” There’s only a flash of recession and no reason why there would be recession in Europe as unemployment has fallen, consumer confidence has increased – higher than any other time since the recession.

 

 

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