China caught in a conundrum over economic policy
Central bank governor Yi’s calming message fails to ease market and currency concerns as NIFD warns of 'financial panic' in leaked report
Stay calm and don’t panic. Sound advice. But it appears no one is listening to Yi Gang, the People’s Bank of China governor. As fears grow of a trade war between Beijing and Washington, the world’s second-largest economy is suffering a severe attack of ‘jitteritis.’
Last week, Yi called for investors to “remain calm” after the benchmark Shanghai Composite Index dropped 3.78%, dipping below the psychological 3,000-point barrier, while the Shenzhen Component Index plunged 5.31%.
Since then, Shanghai has entered bear-market territory, plummeting more than 20% from January highs. On Wednesday, it fell another 1.1% as trade tensions between China and the United States increased, and the renminbi, or yuan, weakened.
To cap a miserable 24 hours, the blue-chip CSI300 index dropped 2.1%, crossing into the world of bear markets. On Thursday, the Shanghai Composite continued its decline, edging lower by 0.9% to close at 2,785.98 points.
All this has made a mockery of Yi’s rare response to this unfolding drama. “Stock markets fall and rise,” Yi said in a statement on the PBOC’s website. “Investors should keep calm and rational,” the head of the country’s de-facto central bank added.
In the past month, market sentiment has started to evaporate after the Chinese government’s sustained battle against debt forced up borrowing costs for businesses. This, in turn, has acted as a brake on the economy.
Coupled with that has been the US-China slugfest, which is looking increasingly like a ‘war of wills’ between President Donald Trump and President Xi Jinping.
Yet stock market volatility and a sustained slide in the renminbi could pose problems for Beijing amid signs of weakening domestic demand, and trade disputes with the US and the European Union.
“We need to adopt bottom-line thinking and draft all types of contingency plans to take targeted measures [to] appropriately deal with the trade friction [with the US],” Wang Yiming, a vice-minister at the Development Research Center of the State Council, an influential think tank, said earlier this week.
For the former deputy secretary-general of the National Development and Reform Commission, the country’s main economic-planning agency, the “Sino-US dispute is the biggest uncertainty,” along with concerns that “export growth in the second half of the year could decline.”
Last month’s data was mixed with exports defying market expectations. But figures released by China’s National Bureau of Statistics revealed retail sales rising by just 8.5%, the slowest pace of expansion since June 2003.
Another key driver of economic growth also showed that infrastructure spending slowed to 9.4%, while fixed-asset investment, a major indicator of domestic demand, was a mere 6.1% between January and May compared to the same period in 2017.
Again, this was the slowest growth since figures were first released in February 1998. “[This was] very worrying,” Wang pointed out, adding that it could be the start of a long-term trend.
Just as “worrying” was a leaked report from the National Institution for Finance & Development, a state-backed think tank, which warned of a potential “financial panic” in the world’s second-largest economy.
Bond defaults, liquidity shortages and market turmoil were highlighted during a period of spiraling trade tensions, a study by NIFD stated.
The report was seen by Bloomberg and Reuters news agencies, and was confirmed by a National Institution for Finance & Development official.
“Financial panic is a type of extreme and collective aversion to risk,” NIFD pointed out in the study, which appeared briefly online before being removed on Monday. “Its occurrence does not mean large-scale financial risk has emerged but is indicative of the apprehension and fear on the part of market participants towards the market’s outlook.
“Preventing its occurrence and spread should be the top priority for our financial and macroeconomic regulators over the next few years,” it added.
The National Institution for Finance & Development stressed that leveraged purchases of shares are reaching levels last seen in 2015. When the bubble burst three years ago, US$5 trillion was wiped off the value of Chinese equities.
“We failed to clean up the leveraged funds after the 2015 market rout [and] they have staged a comeback in a new guise,” the NIFD, which admitted the report had been compiled but said it was being used for internal discussions, added.
A key concern is whether targeted policy support will shore up market sentiment when broader monetary loosening appears to be off the table. “A trade war may bring pressure on Chinese exports, triggering yuan depreciation. Thus the PBOC cannot cut rates,” Yun Xiong, a partner at Leiton Capital in Shanghai, told Reuters.
Options could include incentives to boost domestic demand to compensate for weaker exports, including expanding the government’s annual budget deficit.
In April, the Communist Party’s Politburo, a leading decision-making body, decided to backtrack and add “expanding domestic demand” to a policy statement after dropping it in December.
China could also provide financial assistance in state loans for companies switching from US markets. “We should develop other markets to substitute for the US market,” a policy insider told Reuters. “[But] we need time to [do that].”
In the meantime, the clock appears to be ticking.