Global markets continue to be wobbly. The unexpected weakening of the renminbi in August, combined with the ongoing bust in Chinese equities, has focused attention on the continuing slowdown in China. Fears on global growth are growing, with the emerging markets (EMs) leading the way in negative revisions. The PMI (purchasing managers index) for EMs is both below 50 (signalling contraction in manufacturing) and lower than the PMI reading for the advanced economies. EM import volumes, unlike for the advanced economies, are also negative on a 12-month basis.
A combination of collapsing commodity prices, lack of real reform and the absence of domestic growth drivers has seemingly punctured the EM growth balloon. China is at the centre of the EM slowdown as the combination of its own growth slowing from 10 per cent to approximately 5 per cent, and a mix shift in growth from investment to consumption has delivered a hammer-blow to commodities and EM exporters.
This is obviously very different from the picture over the last decade, wherein EMs and China were the growth drivers of the global economy. According to IMF data, between 2007-14, based on PPP (purchasing power parity) the EM economies accounted for 76 per cent of global growth compared to 24 per cent for the advanced world. China counted for 30 per cent of this 76 per cent - thus China delivered more global growth than all the advanced economies combined. Going forward, the IMF has made projections for 2014-2020. In this forecast horizon, EM economies will account for 70 per cent of global growth; and, of this, 25.6 per cent will come from China. Thus even going forward China is expected to deliver almost as much growth as all the advanced economies. Therefore what happens to China is critical, and thus the understandable angst around the current slowdown.
But how bad is the current slowdown? The truthful answer is that no one really knows. Chinese data is unreliable and difficult to read. The changing mix of growth, away from investment towards consumption, also muddies any interpretation. Look at some indicators. Clearly non-car vehicle sales and machinery sales are down big, showing declines of between 15 and 25 per cent. New orders and business confidence are both down, as well as the prices of most things linked to China like steel, industrial commodities, container freight rates, the Australian dollar, and so on. All data is not negative however: the NBS leading index has turned up; there is improvement in the "Li Keqiang index" as well (the annual growth of railway freight, power consumption and bank lending) and residential square footage sold has also moved into positive territory.
Thus, while China is clearly slowing, it is premature to call this a collapse. We may not have the soft landing everyone had built in as the default, but an economic crisis is by no means assured.
Market participants are worried about a foreign debt crisis being triggered by a weakening renminbi. The People's Bank of China has intervened and kept the currency stable after the first move, declaring that the initial adjustment is complete. Despite these statements, the market continues to fear a weakening currency as capital outflows accelerate. Even if the currency were to fall further, we are unlikely to see a foreign exchange debt crisis of the type which hit other EM economies in the past two decades. China's total foreign currency debt, even including estimates of the forex borrowed by subsidiaries of Chinese companies in Hong Kong, is probably no higher than $1.5 trillion, or 15 per cent of Chinese GDP and 40 per cent of FX reserves. This number does not seem large enough to risk a crisis.
Even the stock market meltdown that we have seen, while painful (markets are down 45 per cent from mid-June) is unlikely to have very significant effects on the real economy. Equity investments are a small share of household wealth in China (about 5 per cent) and thus the negative wealth effect on consumption is likely to be limited. There will be some impact on the brokers and banking system with the margin lending and attempted market bailout, but this should be manageable and contained.
Property prices are the other favourite bugbear of the bear camp, which expects a huge crash at any moment. Here also, while there is speculation, it is not a house of cards, full of only ghost cities. China's property markets are driven more by the fundamentals of a rising urban population and rising real disposable incomes than they are given credit for.
So is there nothing to worry about? Is this all just overheated markets correcting themselves? That would also be wrong, for clearly there are areas of concern.
Investment is down, at its weakest for more than 10 years. Gavekal estimates that real growth in capital formation was only 2-4 per cent in 2014. The adjustment in investment seems to be structural. Construction is now stagnating as housing demand peaks, and this will affect the whole supply chain. Chinese companies are also resetting their growth expectations from the unrealistic levels of the past decade and rethinking their capacity needs. While the government will come in to kick-start infrastructure projects and cushion growth to the downside, the reality is that even in China, private sector investment now makes up two-thirds of the total. This the government cannot control. The transition from investment to consumption as a growth driver is a difficult one for any economy.
China's domestic debt is a major concern. With total debt at 250 per cent of GDP, China is more leveraged than in 2009. Thus today, unlike in 2009 we cannot see a stimulative expansion of credit. This combination of high debt and slowing growth will increase bad debts and weaken the financial system and its capacity to lend and support growth.
Global investors' confidence in the ability of the Chinese leadership to steer a soft landing has been badly damaged. Firstly, encouraging a bubble in equity markets and then trying to prevent the market fallout has damaged the credibility of the leadership as well as investors' belief that they will ever really let market forces prevail. Secondly the decision to let the currency weaken was badly handled, with no prior warning or communication; it spooked investors, who began to wonder how bad the economy was. It has become increasingly clear that the Chinese authorities are not implementing some well-thought-out game plan, but are increasingly ad hoc in their decision making.
Thus while China is not the unmitigated disaster some think, it does have issues. Markets are probably pricing in most of the downside - but a bottoming process in EM will still take some time.
The writer is at Amansa Capital. These views are his own