CHINA CRISIS.

Although Greece has been the centre of attention for the past few months, the travails of China were playing in the background and its problems came to a head over the past week when the country’s main index – the Shanghai Composite Index, skid 24.9% and plunged 44.8% since the bull market peak hit in June. The sense of déjà vu is palpable as it was seven years ago, around this time of year, when stock markets started to gyrate over fear of a debt and liquidity crisis in the West.

This time though the bumpy ride is not due to banks but concerns over the state of the world’s largest economy*. Although the slowdown in growth was well-documented, the panic didn’t seem to set in until recently even though June and July saw the government try to put a floor under the market. Goldman Sachs estimated that it spent as much as 900 bn yuan ($140 bn) to stem the tide while domestic brokers said they would refrain from selling shares until the Shanghai index returned to the 4,500 mark. Their efforts proved fruitless as investors rushed to the exit and started to offload shares in copious amounts.

Recent attempts to allay fears have also not been successful. The People’s Bank of China shaved 25 basis points off the interest rates to 1.75% – the fifth cut since November – as well as further loosened bank lending restrictions. It lowered the reserve requirement ratio for large banks by 50bp, which in effect means injecting liquidity into the sector which had become reluctant to lend. Analysts at Morgan Stanley forecast that around $105bn will be added back into the financial system as a result of the RRR reduction alone.

The actions only resulted in a temporary reprieve and in no time at all, markets continued their downward spiral. The big question of course is whether the government can deliver its promise and transform the economy from one reliant on high levels of investment to a consumer led model. It will not be an easy task as old habits are hard to change. In addition, China’s corporates, provinces and municipalities are highly indebted with many struggling to service their debts while the price of housing far outstrips average earnings, despite recent price falls.

Many analysts expect additional rate cuts and reductions in the bank reserve requirement along with targeted spending on infrastructure investment by local government financing vehicles and increased use of Public-Private Partnerships on various capital projects. It is still too early to predict though whether this will be enough to generate the expected 6% to 7% growth rate. If it fails, it will not only have implications for the country but also the global economy as a whole. The one thing that is certain is that lessons of the financial crisis still need to be digested.

Lynn Strongin Dodds,
Managing Editor

*Based on PPP (Purchasing Power Parity).

A purchasing power parity (PPP) between two countries, A and B, is the ratio of the number of units of country A’s currency needed to purchase in country A the same quantity of a specific good or service as one unit of country B’s currency will purchase in country B. PPPs can be expressed in the currency of either of the countries. In practice, they are usually computed among large numbers of countries and expressed in terms of a single currency, with the U.S. dollar (US$) most commonly used as the base or “numeraire” currency”

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