Interview with Swadicq Nuthay on Chinese Economy Slowdown

1. The talk of the town today is a Chinese hard landing instead of a soft landing... what is a hard landing?

China has already experienced a soft landing, moving from a double-digit growth (14 % in 2007) to 7 % last year. However, internal macro- financial fragilities of China characterised by the real estate and stock market bubbles, debt levels, deterioration of bank balance sheets and "Shadow Banking", make the hypothesis of a hard landing more likely today.

Economists say China's growth potential is less than 6% as compared to 10% ten years ago. The economic slowdown can be partly explained by the fact that the labour force has been declining since 2014 and the rural exodus is well underway. In other words, cheap labour is now gone.

It also appears that Chinese authorities are increasingly finding it difficult to manage the economy and markets, one recent example to illustrate that is the fall of the stock market.

Indeed, growth should be based primarily on productivity gains and structural reforms. Admittedly, the situation resembles the one faced by the Mauritian economy in the 80s and post 90s.

2. The markets have experienced a crazy week including a "black Monday" and a close stock market crash on August 24. What are the causes of these upsets?

Let's just say that all of this is the logical result of a widespread concern related to the effects of the slowdown in the second largest economy as far as major financial centers are concerned.

If we were to go back to the beginning of last month, the Shanghai stock market had already plunged by 12.4 % due to the devaluation of the Yuan. This has brought in its wake, a sense of panic among institutional investors who deserted the equity markets momentarily in favour of market bonds and safer assets like gold.

In addition, many investors now fear a premature withdrawal of the support measures the Chinese government has been heavily investing in since late June to stabilise the local stock exchanges.

It has to be noted that before its collapse in mid-June, the Shanghai Stock Exchange had gone on a 150% surge in the space of a year boosted by debt and totally disconnected from the real economy. The fall of the Chinese market has resulted in a dramatic drop in Asian markets, emerging and developed ones alike.

3. The devaluation of the Chinese Yuan has taken everyone by surprise. What are the impacts this decision will be having on the exchange market?

After years of appreciation of the Yuan against the US dollar, the authorities have maintained the reference exchange rate to 6.1. As such, the reducing of the rate to 6.4 was a major surprise, more so since it represented a depreciation of more than 4% against the dollar. However, it must be pointed out that this depreciation of the Yuan can still be considered as a mild one, following an appreciation of almost 30% against the dollar since 2005, representing an overvaluation of 10% -15 % of the Yuan against the dollar between 2005 and 2013. In addition, the dollar has appreciated significantly against other currencies since 2014. If we were to compare, the real effective dollar, euro and Japanese Yen are respectively 10 %, 10% and 22% above their average over 10 years. In light of these two above-named reasons, the Yuan remains significantly overvalued against the dollar.

The main objective is to weaken the Yuan to restore some competitiveness in the industry and thus help boost a declining activity. However, I still believe that a mild depreciation of the Yuan should be maintained, since the Chinese authorities do not seem keen on a capital outflow increase.

4. As a matter of fact, we are once again talking about a "currency war"? How do you view this phenomenon?

Through this devaluation of the Yuan, China is in fact subtly responding to the Bank of Japan, the European Central Bank and the rapid depreciation of many emerging currencies. Some of those depreciating currencies include the Malaysian Ringgit, which has dropped to its lowest since 17 years; the Thai Baht falling to its lowest during the past six years; the South Korean Won at its lowest in four years, while the Indian Rupee sank as low as 66.48 and the South African Rand to 13.30 against the dollar.

Investors are however warned that the Central Bank of China can again "adjust" the rate of the Yuan if things do not improve. That is a real possibility since this recent devaluation has not addressed China’s high real exchange rate issue. The market will probably anticipate that China will have a more competitive currency, which is precisely the aim of the manoeuvre. Moreover, this will also have an impact on emerging countries’ currencies and their respective economies.

5. They say that one man’s joy is another man’s sorrow. Can this saying be applied to India following the Chinese economic slowdown?

I believe so, and I think it plays at different levels too, with the first one being in line with the financial market volatility. It is clear that India is better placed to deal with this volatility mainly because of its strong economic fundamentals such as its low trade deficit level; its moderate inflation rate; and its foreign currency reserves.

Indeed, India does benefit directly from the commodity price drop.

Based on this assumption, it can be argued that the slowdown of the Chinese economy is a salvation for India, since this approach would encourage investors to turn more towards an alternative growth model rather than focusing on credit-driven growth.

6. What about the impact on prices of raw materials across the world?

The slowdown of the Chinese economy, coupled with the overproduction capacity of raw materials, undoubtedly continues to have an impact on prices of the latter. It is obvious that the economies that depend on these commodities will witness a significant impact. This will be the case mainly in emerging countries such as Brazil, Russia and African countries in particular. Indeed the prices of most materials fell sharply with oil, copper and aluminum dropping to 63%, 33% and 27% respectively from last year’s record levels. With China being the largest petroleum products consumer in recent decades and Middle East countries continuing to increase their production in this area, it is unlikely that oil prices will be increasing anytime soon.

7. What about the Africa/ Mauritius axis?

The consequences will be economically unfavourable for Africa and will, in turn, impact on Mauritius. It should be remembered that the reduction of Chinese domestic demands, in terms of commodities such as oil and minerals, will lead to a shortfall for Africa. For example, the export rate and investment flows will suffer from the fall in commodity price. This will definitely have an impact on our African agenda which could be more difficult to implement if the growth of the black continent follows the same pattern as the Chinese one.

We should also keep in mind that the second largest economy is actively involved in the economy of some African countries besides the geopolitical influence it wants to extend across the continent. We can safely say that China has had a catalytic role to play in Africa's economic growth. But Africa must now review its ambition compared to the slowdown in the Chinese economy, which is likely to impact on both its exports and investment inflows.

8. What are the consequences of a slowdown in the Chinese economy on Mauritius?

On the macro level, a hard landing would have a huge impact on most emerging countries, particularly on emerging exporters and Asian countries already experiencing difficulties. However, the emerging world is economically more important today than during the Asian crisis of 1997 – 1998, weighing almost 40 % of world GDP against 20% in 1997. China alone accounts for 13% of the world GDP. That being said, the global economy will inevitably be impacted. External conditions are unfavourable at the moment. That, coupled with the depreciation of emerging currencies as well as the possible depreciation of the Euro against the dollar (there are speculations that the Euro will be 1.05 against the dollar in the near future), it is evident that the current conditions will not be favourable, unless there is a fall in commodity prices. In the same vein, this will impact investor appetite in relation to emerging countries, including Mauritius.