Why China currency sudden fall

World Economic outlook - Why China currency sudden fall : China’s economy officially grew at an annual rate of 7 per cent during the first half of this year, neatly in line with the government’s full-year target. However, some doubt that figure — Capital Economics, for example, reckons it is 5-6 per cent — and there are widespread suggestions that further stimulus will be needed to prevent a slowdown. 

Yet an export revival would boost growth only marginally. Contrary to received wisdom, China has not pursued so-called “export-led growth” for the past decade. Net exports subtracted 3 per cent from annual growth in Chinese gross domestic product on average from 2004 to 2014. Meanwhile, investment contributed an average of 52 per cent of growth each year.

The sudden fall in China’s currency last week spurred a lively debate about whether the move was a victory for market reform or a competitive devaluation designed to shore up flagging exports.

Qu Hongbin said , HSBC chief China economist. He notes that while China’s exports have fallen this year, “exporters across Asia faced the same challenge, suggesting that the underlying problem is sluggish demand in developed markets”.

China economic data for July may have lacked the lethal explosive force of last night’s detonation in the industrial city of Tianjin, but it laid bare the wider deterioration of domestic macroeconomic conditions.

Though property sales have begun to inch up following 13 consecutive months of decline, the market remains saddled with a huge overhang of unsold flats. That has caused developers to pull back on new construction, hitting demand for basic materials such as steel and cement. Faced with this slowdown, factories that produce these commodities are cutting back both on current output and investment in new capacity.Even more distressing are signs that the production slowdown may finally be feeding through to the labour market.

China’s leaders are sensitive to the risk of social instability from a spike in idle workers, but they have so far been willing to tolerate four consecutive years of economic deceleration because unemployment remained low. That may now be changing.

China’s official unemployment rate is widely dismissed as unreliable, but an index of labour demand based on proprietary survey data from FT Confidential, a research service of the Financial Times, shows labour demand contracting in July for the first time since 2012. The index hit 49.3 last month, down from an average of 67.8 in the first six months. A reading below 50 indicates falling demand for workers.

So far the government has employed targeted stimulus in the form of fiscal spending on infrastructure, while resisting pressure to unleash a wave of lending from commercial banks to the manufacturing sector, as in 2008. That stimulus plan led to a quadrupling of China’s economy-wide debt from $7tn in 2007 to $28tn by mid-2014, equivalent to 282 per cent of GDP. But if the job market continues to worsen, pressure for drastic measures will increase. 

The wild card is deflation. Wholesale prices have fallen for 40 consecutive months, with the decline accelerating in July. Falling global commodity prices are largely to blame for Chinese deflation, but that is cold comfort for indebted companies whose nominal cash flows are in decline, even as the debt they owe remains fixed.

In an illustration deflation is undermining deleveraging efforts, China’s debt-to-GDP ratio has continued to rise this year, even as new borrowing fell 21 per cent in the first seven months from the year-earlier period. That is because disinflation has caused nominal GDP to slow even more sharply than outstanding debt.

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