Policies can’t be benchmarked against stock market index


By Andrew Sheng ,Asia News Network

The new year started not with a bang but a whimper. IMF Managing Director Christine Lagarde’s prognosis at 2015 year-end was that global growth in 2016 would be “disappointing and patchy,” blaming rising U.S. interest rates, the economic slowdown in China, persistent financial fragility in several countries and lower oil and commodity prices. Sure enough, on the first day of market opening on Monday, Jan. 4, the Shanghai A share market fell 7 percent (and again on Thursday, Jan. 7), dragging global stock markets with it. The dominant story in 2015 was the slowdown of the Chinese economy and its impact on global commodity prices, including demand on luxury goods. Would this trend continue into 2016? The IMF 2015 Article IV consultation on China, arguably the best available official “health-check report,” commented in August last year that China was “transitioning to a new normal, with slower yet safer and more sustainable growth.” Growth in 2014 fell to 7.4 percent and was forecast to slow further to 6.8 percent in 2015. Sure enough, by October, the IMF World Economic Outlook forecast was 6.3 percent for 2016, not bad by any standards, but slower than that for India (7.5 percent), currently the darling of foreign investors. There are good reasons for being cautious because of the rising risks. The foreign press analyses of the Chinese economy are almost uniformly pessimistic. Not only do they think that there will be a hard landing, several analysts think that a financial crash is inevitable. The facts are quite clear on the risks.

Firstly, between 2008 and 2014, China’s private debt to GDP ratio rose by 73 percent points. The famous Reinhart and Rogoff (2009) book, “This Time is Different,” suggested that fast rising private debt is the best indicator of financial crises and in the last five years, Chinese debt has grown fastest in terms of total debt.

Secondly, the economy is clearly slowing with both manufacturing and, recently, service sector indicators showing negative or slowdowns. Thirdly, since July last year, despite market intervention, the stock market index is still signaling downward. Bank of America Merrill Lynch analysts are predicting a Shanghai Composite Index level of 2,600 for 2016, compared with peak levels of 5,178 in June last year and current levels of 3,100. Fourthly, there are capital outflows and concerns on yuan depreciation. On the plus side, proponents argue that so far, the labor market has remained resilient because of the shift toward a more labor-intensive service sector. Household consumption has remained fairly firm, while inflation has been flat, helped by lower commodity and energy prices. Unlike advanced countries, Chinese fiscal policy has much more room to maneuver, because total government debt was still less than 60 percent of GDP at the end of 2014. By allowing more interest rate and exchange rate flexibility, the room to use monetary policy by the People’s Bank has been strengthened.