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Status of China’s Economy: Economy Doomsday Predictions, Stock Market Crash, Yuan Devaluation &#8211

Opinions of C3S members on the subject of China’s economy are given below:

On predictions of doomsday of China’s economy :

(March 29-March 30, 2015)

Cmde. R. S. Vasan IN (Retd.),

Director, C3S.

A very interesting piece by Claude Arpi : http://www.niticentral.com/2015/03/28/will-china-crack-up-308321.html  .

There are many of our members whose views would resonate with those expressed. The debate of when or whether China will break up will go on till dooms day.

B.S. Raghavan IAS (Retd), Former Policy Advisor to UN (FAO), Chief Secretary, State Governments of West Bengal and Tripura, Secretary to the Ministry of Food and Agriculture, Government of India.

The emergence of China as an economic super-power, holding its own with, and surpassing, the U.S, is now taken for granted. This has inspired a lot of stories propagating doomsday scenarios. They mostly reflect the frustration of the West in regard to China adhering to its own political model rebuffing the efforts of the West to impose its own. China’s pre-eminence, in short, threatens the postulates that the West has long cherished. That has generated a fear in the Western mind about the political, social and functional paradigm that it represents becoming universal.

Scholars pickled in Western notions of nation states, and fixated on what they hold to be self-evident truths driving their institutional props get it all wrong when they try to transpose them to the Chinese context. Such a self-righteous and supremacist approach has led to a seriously flawed understanding of the Chinese phenomenon.

Observers also sometimes avow surprise over the rapid strides China has made. They forget that China (as much as India, be it added) has been no stranger to stunning achievements in its history of 5,000 or more years.

In fact, until 200 years ago, China outshone the West in every political, economic and social parameter defining superior record of performance, be it a strong and stable government, technological prowess marked by creativity and innovation, or wealth generation.

Long before the thinkers the West swears by such as Plato, Aristotle, Voltaire, Rousseau, Locke and Paine (just to mention a few) were known, Chinese culture and civilisation had attained a matchless depth and range, and the overarching ideals and precepts of Confucian philosophy suffused by Buddhism-inspired spiritual efflorescence had become the bedrock of the Chinese society. Indeed, China’s current brand of communism itself has mutated from all that went before it.

Thus, although the rules of the game as played by China seem outwardly arcane and untenable to Western, and Western brain-washed, minds, they are in fact rooted in values and traditions fundamental to its evolution, and, indeed, very existence. It is not that China is not changing, but it is calibrating that change as suits its own cultural and civilisational imperatives. China is a “civilisational state”, and not a “nation state” which is the only term the West-oriented commentators understand.

As a recent book (“When China rules the world” by Martin Jacques, a columnist of The Guardian of London and a visiting scholar at the London School of Economics), aptly puts it “the country’s cultural core resembles ancient China far more than it does modern Europe or the United States. It is accumulating wealth much faster than it is absorbing foreign ideas. China is not emerging on the world stage as a new, powerful nation-state. It is, instead… regaining ‘lost international status,’ becoming the first ancient civilisation to re-emerge and reclaim its position as a dominant power.”

In this background, it is a sign of fossilised mind to insist on the infallibility of one’s own interpretation of concepts such as the rule of law, equality before law, human rights, elections, people’s will and consent and legal remedies. It is conceivable that they may not take the same form in every context and in every place and may undergo mutation reflecting the prevailing circumstances. In any case, as Alexander Pope said: “For forms of government let fools contest/Whate’er is best administered is best”.

China is a country ruled by a single monolithic Party, which has made sure of having its vast military machine within its fold and whose binding principles are unity, uniformity and unanimity. Its policies are avowedly the result of extensive intra-party consultations and introspections (or reviews) from the village units upwards and once in place, are to be unquestioningly acted upon at all levels.

This, strictly construed, is not a feature deriving from the traditional understanding of Marxism-Leninism, but is one of the many Chinese characteristics of its political and economic dispensations. Indeed, in its fundamentals, and in its application to the affairs of state, Chinese communism borrows from the basic beliefs of Confucianism, one of which being that the wise, all-knowing state knows what is best for the people at large. The use of the expression (core interests) itself is evidence of Confucian characteristics dominating Chinese communism. For, it is simply the literal translation of hexin liyi which was central to the Confucian principles of statecraft.

Thus, whoever the leaders rising to the top, they will have to necessarily function within the ideological superstructure that has become both sacrosanct and immutable. In that sense, they are no different from apparatchiks and it is unrealistic to expect them to deviate from a course that had also stood the country in good stead and brought it to the present stage of pre-eminence. And that pre-eminence will last a while, notwithstanding the forecasts of doom by wishful thinkers.

K.Subramanian

Former Joint Secretary (Retd.) Ministry of Finance, Government of India.

Many ‘scholars’ and analysts in the west have foretold the doom story that is China. ​Often, they are in the vanguard promoting the virtues of the west which, according to them can bring salvation. I remember, about ten years ago, there was not one financial analyst or economist who did not predict the collapse of China’s banking system. Many of them met in Basel in a brainstorming session and advised Mr. Zhou, who was then the Chairman of the PBOC and continues in that post, that China should adopt the western model and reform its banks. Zhou told them that he and his government were aware of the problems and would solve them adopting their own methods. It is the western banking system – the giants which were thought to be “too big to fail” – which has collapsed while China’s banks are surging ahead. I am not saying that they are paragons of virtue. But those in the whore house should not preach morals.

So is the case with China’s political system. There is not one analyst – right, left or center- who has not reviled it or criticized over its rights, freedom, etc. The CCP and its policymaking bodies seem to be more representative (or sensitive to) the welfare of the people than any democracy in the world. Lifting 300 million people out of poverty in three decades is no mean record. In India, the same democratic forces so-called, seem to work against the poor driven by stratified and casteist structures. I am not defending the political system in China. But it has greater strength and national purpose than the US Congress which is stuck in factionalism and finds itself in the grip of corporate corruption and lobbying. It can’t agree on fiscal policies when its economy is in deep distress. It has been so since 2008 and there is no light at the end of the tunnel. London Economist has been praying for greater wisdom on the part of Congress in its recent issues. It is not a prayer – it is a lament. The critics of China are not aware of the problems in their own backyard!

Ambassador Ganapathi IFS (Retd.), Former Secretary (West), Ministry of External Affairs, Government of India.

The doomsayers (on China’s economy) are primarily opinion makers and policy formulators who would not like to see a non-Western country prosper – yet they make line for it as in AIIB.

China has stood up to the West.  Lee Kuan Yew is admired for this very reason – after being exposed to him during my posting in SIngapore.  He proved all his critics wrong to take a “Third World country to the first World”.

Here is a very pertinent and relevant article in today’s Business Standard which brings out the arguments along lines similar to the observations made by C3S members:

K.Subramanian

On the piece by Andrew Sheng and Xiao Geng (quoted by Amb.Ganapathi):  I have always admired Sheng and his group of economists for their analysis of global financial markets and providing an alternative view for the EMEs. Dr. Y.V. Reddy, former Governor of the RBI, was in close touch with him and was greatly influenced by him​. In fact, he dedicated one of his books to Sheng. At a time when monetary economics was “seized’ by neo-classical economics, in Sheng and some other Chinese economists which included Dr. Zhou Xiachuan, we saw the arrival of this school which guided China’s policymakers. It is in recent years, in the wake of the utter failure of monetary tools and the waste of resources estimated at $3 trillion on QE programs, that there is recognition of the “alternative” views. The secret is not in any attempt to get a straight-jacket; but, to be adaptive, incremental and experimental. Many of us seem to think that China’s authoritarian system is doomed. It appears, it is more adaptive and creative than the US Congress which cannot even agree to set right its fiscal woes!

On China’s Stock Market Crash

July 8- July 9, 2015

T.V. Krishnamurthy

Management Professional, Chennai.

Both these links are worth reading:

But the comments in the Indian media betray complete ignorance on the composition and dynamics of traded stocks in Shanghai & Hong Kong, including the size vis-à-vis GDP.

B.S Raghavan

I found this link useful in understanding what I consider to be a freak phenomenon:

K. Subramanian

One of the earliest articles on China’s stock market boom was covered by the Economist in December last: China’s stockmarket crash: A red flag

The New York Times (NYT) has carried several articles (on a day to day basis) on the subject. Keith Brasher is the senior journalist who is a well known China hand.

Many of these reports are jubilant as they see a China “cracking” or “crashing.” Some are objective and sympathetic.

One may trace the roots of the present crisis to the efforts of the Chinese government to create a capital market which is broad-based, facilitates capital flow of capital and reduces dependence on banks for capital raising. This is the broad frame of China’s reform policy. Last June the scheme was put through and Shanghai stock market was linked with Hong Kong. Foreign investors were also allowed more freedom to operate in the stock market. This package was combined with the other monetary policy measures like reducing interest rate, providing more liquidity to banks, reducing loan to deposit ratios, cash reserve, etc.

These measures are a part of the longer term strategy. In the U.S./China Strategic and Economic Dialogue (SED) China is committed to opening its capital market and allow greater freedom for market. Some of the senior advisers, especially in the PBoC, take the view that market allocation of capital is more efficient than bank-financing. Currently, the strategy is investment driven which again is bank oriented. This strategy has become unsustainable.

There are other major considerations. China is very keen to have the yuan included in the SDR and it seems clear that even the pundits in the IMF are favorably inclined. In that context, some of the critics argue that China’s capital market is not deep. Also, there is pressure that its interest rate should not be fixed by government (central bank) and be market driven. While I have no direct evidence, my own inference is that China started its capital market loosening with these objectives in view. Bradsher writes in today’s NYT (July 9) that one of the aims of driving up the stock value was to create a favorable field for divestiture of some of the major state-owned-companies (SOEs.)

The behavior of the stock market seems to have shocked the Chinese authorities. The market had over reached with maniacal zeal and began to crash. At that point, the authorities made several efforts to provide support and these were of no avail. Now they have applied other tools to bring them under control. Unlike Western (including Indian) governments, China does not operate only on monetary policy tools. It can intervene in other ways such as stopping bank credit, issuing advisories and other administrative measures. Many observers feel that the villain of the piece was the leveraged purchases, i.e. buying shares against margin money which is borrowed from banks. (Incidentally, Indian banks are not allowed to lend margin for purchase of shares.) There has been a growth of thousands of small companies alongside banks which are unregistered. It is the cohabitation of this class which has created the havoc. By instinct, Chinese are gamblers. They are like our people running after chit fund companies offering the moon for a farthing. China witnessed a similar ‘boom’ in the stock market five or six years ago.

As far as China’s economy goes, the fluctuations in the stock market will have no effect. The volume handled is estimated at one third of GDP. There has been no reliance as such on the stock market for raising capital for industries or infrastructure. The most serious consequence, as reported by many financial papers, is that millions of small investors (average and poor citizens) are in distress and this could cause issues concerning social stability. These have been queered by the internet and the government had to pay heed.

One long term effect, as pointed by Keith Brasher, is that it will delay China’s reform proposals. They have already decided to defer the linking of Shanghai Stock Exchange with Shenzen. There will be in granting further facilities for non-residents to operate in the exchanges.

On the whole there will be no setback to the modernization. Unlike India where we attempt to put through reforms at midnight and keep no options to roll back, China undertakes all reform measures experimentally, incrementally and cautiously. After watching the behavior of the stock markets, they can re-calibrate.  There has been a continuing debate (war!) between older generation die-hards and the newer generation modernizers over the reform process. The present crisis gives the advantage to the old guards.

T.V. Krishnamurthy

I am expecting the Chinese Securities Board and Central Bank to come out with some measures and statement which is intended to maintain public confidence in the stock markets in China. That will happen after the meet in Russia which is not directly related, but tactically speaking.

It is possible that the traders in Hong Kong have manipulated the Shanghai markets. The Chinese in Hong Kong are capable of overturning any market.

In so far as their economy is concerned the slowdown is bound to continue, because of Demand Supply mismatches both within and outside China.

The current stock market debacle should not be confused with economic slowdown. That effect can happen much later.

Mr.Sivaraman IAS (Retd.),

Former Revenue Secretary, Ministry of Finance

Government of India.

The China lovers may see the issue with different coloured spectacles than those who are objective.

The fact is that since last July the stock market in China made a steep upward surge further pushed by it allowing foreigners to purchase stocks through Hong Kong.

The Chinese hold their savings mostly in bank deposits at almost 60% or almost 100%.

Of late they started rolling into the stock market. In spite of restrictions on bank borrowing to finance stock purchases the Chinese like Indians and many others circumvented rules and banks also lent money. This became a flood from last September/ October when stock prices dizzied up when the Chinese economy was slowing down. That itself should have made the authorities to go on guard but their efforts were feeble. It reminds one of the Harshad Mehta scam in reverse. While we did not apply the circuit breakers on time China has applied it now since yesterday. But their efforts apply to 40% of the stocks.

What has to be seen is how it affects the banks when they make a margin call.

We cannot keep on saying China will do this, China will do that, as China has four trillion dollars in reserves and so on. It is not possible for any government to just draw down the reserves as and when it pleases. It has a time lag and consequences.

Stock market speculation affects sentiments but it has no direct impact on growth at least in the short term. The problem comes only when IPOs are not able to find their way in a collapsed stock market.

We have to read every opinion as the opinion makers always wear their own coloured spectacles.

Unless Chinese stocks go below last July level the market can always reboot.

Additional Comments by Mr. Sivaraman

Chinese markets may be unwinding from the unusual rise in the last six months. As the economy is not springing and just chugging along operators might be trying to get out.

When speculators unwind there is a crowd at the exit door.

Chinese government is pumping in huge amounts to arrest the slide but even today (July 8) it has slid even further. They are buying stocks through various means but this has not arrested the fall so far.

But boosting prices in the stock market by the government buying up stocks is not the best option.

The danger now is how much the exposure of shadow banking activities of corporates have been hit by this slide. If corporates have bought stocks by borrowing from the shadow banking system and boosted stock prices at one time to gain arbitrage they are in for a double whammy.

The government has applied the circuit breaker on the 1400 stocks which stopped trading in Shanghai today (July 8). India did not apply the circuit breaker when the Harshad Mehta scam broke out.

But India did not break down as our stock market was very thin, and the banks that were hit somehow or other came out with many heads rolling.

In the army you do a front roll with the weapon tucked on your chest to attack a post you unwind as you come out of the roll and open up with the weapon.

No such remedy is there right now but panic should not creep in.

On China’s Devaluation of the Yuan

August 13-August 16, 2015

K.Subramanian

Summary of K. Subramanian’s Interview on BBC Tamil (http://www.bbc.com/tamil/india/2015/08/150812_yuandevaluation_rupee)

A further fall in the value of the yuan, China’s currency, is expected after the actions of the Chinese Central Bank. China continues to follow the policy of intervention in its Central Bank. The US Central Bank may increase interest rates over the next few weeks as a precaution due to the expectation that China will again reduce the value of its currency. The reduction in the value of yuan will significantly affect the Indian economy. India can be hit by both sides, as it will have to pay additional prices when importing from China, while simultaneously seeing a decrease in the international price of exported goods.

In response, the Indian government must reduce the value of its rupee. However the question of political support remains.

China wants the yuan to be included in the economic assistance process of the IMF, which currently uses the dollar, euro and pound.

However the IMF is dissatisfied with the current situation. IMF wants the value of yuan to be determined by the market forces and China is also agreeable. However, by intervening regularly in the market China does not want to jeopardize its case for inclusion of yuan in the SDR. China has been treating yuan inclusion in the SDR basket as a major macroeconomic objective since 2008.

Additional comments by K. Subramanian:

Recent policies and actions taken by China, especially its Central Bank (PBoC), clearly indicate that there is a great drive towards a market-determined yuan rate and give up the earlier stance of ‘managing’ the rate officially. The IMF gave a clean chit to China when it brought out its last Article IV Consultation Report a couple of months ago. In that report the IMF pundits have clearly said that yuan rate is not undervalued and is being set by the market. The US Treasury’s Semi Annual Report on world currency exchange rates (April, 2015) credited China for allowing yuan to rise in recent years.

On China’s claim for including yuan in the SDR, readers are requested to read the IMF Report (Review of the Method of Valuation of the SDR- Initial Considerations, August 3, 2015.) Unlike in many of its earlier assessments, this Report gives a very favourable assessment of yuan’s candidature for inclusion in the SDR. The only debate, if at all, may be on the issue whether yuan is a “freely usable currency” even as it is ‘widely used.’ As the Report itself says, this is judgmental. All the Members of G-7 are agreeable to include yuan and only the US has reservations. Sadly, this is dhayadhi syndrome as we say in this part of the world. Incidentally, the US cannot veto the proposal as it requires 70 percent votes and not 85. Other members can outvote the U.S if they want.

Mr. Sivaraman

What is mysterious about China is that it still has an export surplus of over USD 400 million in July 2015. Its inflation rate is still low. Its GDP is still growing at 6 percent per annum. It has a huge reserve of nearly 4 trillion dollars, by normal logic the yuan should appreciate steadily.

If India had been in a similar situation its rupee would have hit 30 to a dollar and rising still. Then why did the renminbi fall albeit insignificantly? The yuan was around 2.5 to a dollar in the 1970s similar to the Indian rupee which was holding against the dollar artificially no doubt. But as the Chinese economy grew its renminbi fell and as it gathered momentum so did its currency downwards till it became a little more than 8 to a dollar.

Normal economic theory seems to be inapplicable to China. Perhaps the development in complexity economics and access to super computers will someday unravel it for the world although China itself may know the truth.

Neo classical economics is graduating to complexity and behavioural economics. But it has a long way to go to get into a serious analytical mode. As the variables tangible and intangible are so many that it will be difficult to create functions of dependant and independent variables to solve even a linear equation. In complexity and behavioural economics non linearity will be the order of the day.

Hong Kong and Singapore thrived on capital flows which were undoubtedly of questionable origins. When they were getting all the capital we were moralising about it.

Global liquidity now is unbalanced with the bulk of the reserves with China, Taiwan, Germany, Singapore, Japan and Southeast Asian countries along with India to a modest extent.

There are of course in addition reserves of the private sector over a trillion each in the US and Japan perhaps more.

(The views expressed are the C3S members’ own.)

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