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Are we headed for a 2008-like financial crisis? George Soros, the man with the reputation of breaking the Bank of England thinks so. “When I look at the financial markets, there is a serious challenge which reminds me of the crisis we had in 2008," Soros was quoted saying by Bloomberg last week. The veteran hedge fund manager is worried about China and thinks it is finding the adjustment difficult. Volatility in the financial markets last week showed that the fear is widely shared across the world.

The Chinese economy is slowing and is being steered towards a more sustainable growth model, which is not dependent on manufacturing exports. However, dealing with past excesses and ensuring a soft landing is an issue. China contributes about 16% to world gross domestic product (GDP) and has provided strength to the global economy after the 2008 financial crisis.

A sharp slowdown in China will not only affect overall global growth, but will be particularly harsh for its close trading partners. For example, as shown by the World Bank, an unexpected one percentage point growth decline in China would lower growth in the rest of Asia by 0.5-1.4 percentage points after two years. (Global Economic Prospects, January 2016). A sharp slowdown will have a disproportionate impact on commodity exporters. In fact, the slowdown in China is one of the biggest reasons for the weaknesses in commodity prices.

Weakening economic activity is not the only problem. China is also witnessing serious capital flight. To be sure, policymakers want a weaker currency but are worried about disorderly depreciation. It is being reported that the central bank burnt at least $100 billion in December 2015 alone to defend the renminbi. The worry is that China will once again use weaker currency to support economic activity, which has prompted some of the businesses and households to move out of renminbi-denominated assets.

There is also a high-debt angle to the story. According to McKinsey, total debt in China in mid-2014 was at 282% of GDP, which is higher than the debt of some of the advanced economies, such as the US and Germany, and has quadrupled from the level in 2007. Over-investment and slower growth would naturally make debt servicing difficult.

There are layers of issues confronting China at this stage which will keep the financial markets guessing. However, as things stand today, it is difficult to argue that the world is close to a 2008-like financial crisis. In 2008, part of the US economy was engaged in excessive speculation, expecting that good times will continue, and when financial conditions tightened, the result was a collapse in asset prices—a perfect Minsky moment—which brought the financial system to a standstill.

Conditions in China are a little different. China is not essentially struggling to contain speculation and asset-price inflation, but is shifting to a different growth model. It has accumulated excesses in terms of over-investment in various sectors, but debt is mostly concentrated with state-owned enterprises. In fact, households in China are in a lot better shape than they were in the US in 2008. Further, the US was far more financially integrated with the rest of the world than China is today, which will limit the impact. Also, unlike the US, China’s financial system is tightly controlled by the state.

This is not to suggest that a crisis in China will not have any impact on the global economy, but it is unlikely to be close to 2008. However, commodity export-dependent economies will remain in a difficult spot, as demand will remain capped because of a slowdown in China and weak global growth.

What does this mean for India? Policymakers in India will have to remain vigilant and find ways to grow at a time when global growth is likely to remain tepid for an extended period. India will also have to convince global investors that it does not belong to the typical commodity-exporting emerging market pack, and is also not suffering from some of the problems that China is facing. Foreign portfolio flows could become more volatile because of a change in investor preference away from emerging markets.

India should, therefore, prepare the ground for attracting foreign direct investment, which is more serious in nature and is likely to be attracted to a long-term growth promise.

Is the world headed for a 2008-like financial crisis? Tell us at views@livemint.com

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