BackBoom now; devaluation later
When China's growth slowdown becomes truly unbearable, a devaluation will be firmly on the table and will be carried out
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hina has been in the news lately. Its first-quarter gross domestic product (GDP) growth of 7% was reported as the weakest in six years. Other unofficial estimates—based on indicators of economic growth tracked separately by Chinese Premier Li Keqiang—put the growth rate between 1.6% and 3%. China’s exports plunged in March after soaring in February. For all the brave talk of rebalancing growth towards domestic consumption, China is more and not less reliant on exports as imports are falling even faster. In other words, as domestic spending slows more, net exports are still making a sizeable contribution to economic growth. In the meantime, China is witnessing a frenetic stock market boom that is putting the US’s and Europe’s to shame. China’s economy is no longer walking on the edge. It has fallen, except that we do not see it in the official statistics. Despite that, China’s stock market is now sprinting towards the edge of the cliff. When it falls, it will be spectacular. The consequences for China are going to be severe and far-reaching for the rest of the world when (not if) it happens.
The stock market bubble in China is spectacular both for its size and the speed with which it has grown. It is not just technology stocks that are on fire, although the average Chinese technology stock has a price-to-earnings ratio 41% above that of US peers in 2000. The use of margin debt is at an all-time high. More worrying than valuations in technology stocks are perhaps the health-goods-from-deer-antlers producer on 70 times, the seamless underwear manufacturer on 90 times or those school uniform and ketchup makers on 330 times.
China’s stock bubble has inflated at a time when its money supply growth rate (M2) has fallen to below 10%. Hence, as a perceptive blogger put it, the stock market bubble has already discounted quantitative easing (QE) in China. Otherwise, in the face of bad and worsening economic and corporate fundamentals (high debt and low return on capital), there is not even a fig leaf of justification for the stock market bubble in China as in the case of the US and Europe. On cue, over the weekend, the People’s Bank of China cut the reserve requirement ratio (RRR) by 1 percentage point, the largest cut since 2008. It releases around 1.3 trillion renminbi of liquidity. Lest we think that the central bank had not run an irresponsible monetary policy until now by implementing QE, we should not forget China had been doing its own version of QE even before 2008, except that it had bought the government paper of the US mostly and not that of its own. The impact on the domestic money supply has been the same. The size of the balance sheet of the bank is around 50% to 60% of GDP and is eclipsed by that of the balance sheet of the Bank of Japan. Talk of Asian values.
In his Breaking Views column for Reuters, Andy Mukherjee wrote the lightness of China’s growth had not become unbearable because it had desisted, so far, from devaluing the currency. I am not sure this restraint would last long. It has resisted the temptation to address domestic economic weakness with a currency devaluation for three reasons. One is that there is excessive capital outflow. China’s rich are taking their money out. A currency depreciation might hasten the outflow and put further pressure on China’s foreign exchange reserves, which have come off $4 trillion already. Pressure on the currency, capital outflows and draining of foreign exchange reserves do not sit comfortably with the pursuit of a seat at the high table of global reserve currencies and membership in the special drawing rights basket. That is the second reason why a renminbi devaluation has not been pursued until now.
The third reason is the oft-discussed change in the monetary policy stance in the US. In her most recent speech, Janet Yellen, chairperson of the US Federal Reserve, had hinted at her preference to get the federal funds rate off its zero base sooner rather than later. That much comes through despite all the qualifications and exceptions in her speech. China has a lot of short-term (residual maturity of less than a year) external debt that need to be rolled over. Higher US interest rates and a cheaper yuan make servicing foreign debt costlier and push some marginal cases into debt default with the risk of a bandwagon effect on domestic debt too. Therefore, we should note here that China is biding its time to devalue the renminbi rather than foreclosing on that policy option. When China’s growth slowdown becomes truly unbearable, a devaluation will be firmly on the table and will be carried out. Yours truly believes that currency devaluation by China will be carried out sometime in the next 12 months.
That will have a huge impact on the vain attempts being made by the US, Europe and Japan to resuscitate their economies through their musical-chair game of currency weakness. That game will come to naught. India will be affected badly. A country of free riders—as V. Raghunathan put it in his book, Games Indians Play—depends, forever, on the uncompetitiveness of others. More on that later.
V. Anantha Nageswaran is co-founder of Aavishkaar Venture Fund and Takshashila Institution.
Comments are welcome at baretalk@livemint.com. To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk
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