World Trusts RBI’s Rajan, Not Impressed by Chinese Policymakers

Why are foreign investors wary of China’s policymakers but enthused by India?

Stock market and currency turmoil has battered Chinese leaders’ reputation as shrewd economic managers and fed doubts about their willingness to push through more wrenching reforms.

In the stock market, a “circuit breaker” to suspend trading in the event of wide price swings backfired and fuelled steeper falls. It was withdrawn after just four days. That followed complaints about curbs on stock sales and other emergency measures imposed to stop last year’s market plunge were clumsy and fuelled investor panic.

In currency markets, Beijing has struggled to squelch expectations it plans to devalue the yuan. That has forced the government to spend tens of billions of dollars to defend the exchange rate.

Such volatility is common in developing countries, but China’s status as the world’s second-largest economy and biggest trader mean missteps cause global shockwaves. And the latest turmoil has a political tinge because it comes as Beijing is promoting a bigger role for itself as a regional military power and in managing international trade and finance.

Keeping Market Forces at Bay

The Communist Party under President Xi Jinping wants the prosperity that comes from free-market competition and has promised entrepreneurs a bigger role in the state-dominated economy. But when stock prices plunged last June, the party reached back to the era of central planning for the sledgehammer of direct government control. It banned sales by large shareholders and ordered state companies to buy.

Forecasters who expect China to keep growing at a healthy rate “pinned that expectation on a belief that market forces will be given greater play,” said Mark Williams, chief Asia economist for Capital Economics.

If the government cannot bring itself to allow market forces to be felt in China, then the outlook is a lot grimmer.

Dubious Moves

• A “circuit breaker” to suspend trading in the event of wide price swings backfired and fuelled steeper falls. It was later withdrawn.
  
• Curbs on stock sales and other emergency measures to stop last year’s market plunge fuelled investor panic.
  
• Beijing has struggled to squelch expectations it plans to devalue the yuan.
  
• The government was forced to spend tens of billions of dollars to defend the exchange rate.
  
• China’s status as the world’s second-largest economy and biggest trader mean missteps cause global shockwaves.
  

At Loggerheads: Reform & Control

Beijing’s moves on stocks and currency “are indicative of tension between the leadership’s desire for market-oriented reform and the apparent fundamental objective of control,” said Louis Kuijs of Oxford Economics in a report.

How this tension will be resolved in the coming years will be central to China’s economic development and thus will have major global ramifications.

The latest turbulence is a blemish on an acclaimed record of achievement as party leaders steered China through two decades of explosive growth to become the world’s second-largest economy.

The World Bank and other advisers say China has reached a point where the economy no longer can be micromanaged by bureaucrats if it is to keep growing.

Last year’s economic growth, due to be reported next week, is forecast to have slowed to 7 percent or below. That still would be the world’s second-highest, surpassed only by India, which is one-tenth China’s size.

But growth is forecast to fall further this year and economists say it will dwindle to dangerously low levels without more private competition. That raises the risk of job losses and political unrest.

Foreign Investors Hit the Panic Button

For investors abroad who lack a detailed understanding of Chinese economic management, the stock market rout shook their confidence in China’s leaders, said Bernard Aw, a strategist for IG in Singapore.

Of course, the backtracking on the circuit breakers, that kind of news makes the misunderstanding even deeper. It also creates the impression that, Oh, they are doing trial and error, they don’t know what they are doing.

Bernard Aw

In August, the central bank startled global markets by announcing it would use a new mechanism to make yuan’s state-set exchange rate more market-oriented. The People’s Bank of China gave few details and allowed the yuan to fall 2 percent against the dollar the first day, stirring fears of a steeper decline and possible competitive devaluations by other governments.

After weeks of uncertainty, Premier Li Keqiang tried to mollify concern by telling an audience of business people on 9 September that Beijing had no plans for a “continuous devaluation.” But over the four months since then, the central bank appeared to contradict that by allowing the yuan to fall another 3.4 percent to a five-year low against the dollar.

China’s Pain is India’s Gain?

The uncertainty has led to a capital outflow of tens of billions of dollars a month. Financial analysts say investors don’t believe repeated promises to avoid a bigger decline, so they are shifting assets abroad before anything valued in yuan loses value.

Williams, of Capital Economics, points to the counter-example of India, where central bank governor RaghuramRajan is credited with cooling inflation since 2013 with a strategy that included talking in detail about his goals.

“There is a much greater sense of trust among businesses and households toward the (Indian) central bank,” said Williams, “and we just don’t see that at all in China.”