If the biggest external vulnerability for the global economy during 2015 was the rate hike by the US Federal Reserve, the looming concern this year is likely to be China.
So while in December, when Fed Chair Janet Yellen finally raised the interest rates by 0.25 per cent, skittish markets around the world had plenty of time to price this in. The problem with the unfolding Chinese stock market and currency crisis is the unpredictability of it all, as policy makers in China grapple with the challenge of handling the transition from an export-driven economic model to one where domestic demand drives growth. On Thursday, trading on mainland Chinese markets were halted for the day after shares fell more than 7 per cent for the second time this week. The “circuit-breaker” rule that was brought in to curb volatility, was triggered in the first 30 minutes of trading, making it China’s shortest ever trading day. After the trading halt, the China Securities Regulatory Commission announced that major shareholders could not sell more than 1 per cent of a company’s shares within three months as of January 9. The new ban comes as a previous six-month ban of stock sales by major shareholders is set to expire on Friday.
The stock market tumble, though, is the result of a trigger in the currency markets, something that the Chinese central bank tried to circumvent through an intervention in the currency market. The People’s Bank of China (PBOC) guided the yuan lower on Thursday at the fastest pace since its shock devaluation last August, resulting in the slide in mainland China stocks and the cascading impact across markets elsewhere.
The PBOC set the yuan reference rate at 6.5646 against the dollar, down 0.51 per cent from Wednesday’s quote, and the lowest mid-point since 2011. According to Reuters data, that represented the largest daily change in the fix since August 13, 2015.
What are the worries stemming from this action? The immediate impact is a sell-off rally in major emerging economies. Indian stocks slid to a four-month low, with Tata Motors, owner of JLR, and Tata Steel were the worst performers on the BSE Sensex during mid-day trade as the benchmark index tumbled 555 points in a fourth day of losses.
The PBOC’s currency intervention has revived worries in financial markets, from the broader health of the Chinese economy to the impact of a weaker yuan on capital outflows, which have surged in recent months. The Chinese central bank action points to the possibility of Beijing looking to boost exports, as China’s economy may be slowing more than expected. Analysts also expect other emerging economies to start competitive devaluation, or letting their currencies weaken to maintain competitiveness, something that has been flagged as a big worry by central bankers around the world, including RBI Governor Raghuram Rajan. In August 2015, Rajan had, while stating that China’s devaluation of the yuan (then) was not a concern, warned of the dangers of “tit-for-tat” actions by other countries if the move was part of a long-term competitive devaluation. Although Rajan said he did not believe the actions from the PBOC were an indication of a long-term devaluation, he warned of the dangers if it were part of countries resorting to a process of getting competitive advantage through longer term depreciation. Especially of such action in a scenario of “only so much global demand and if we all are trying to capture it by depreciating our currency”, which, he said, could lead to a “free-for-all”.
What are the implications for India? A Chinese yuan-led competitive devaluation across the emerging markets could spell more bad news for India’s exports sector, which was in the negative for the 12th straight month in November 2015 and contracted by over 18 per cent year-on-year during April-November this fiscal to $174.3 billion. India’s export sectors that could be affected include textiles and garments, where China has been losing competitiveness over the years.
Then there is an impact on Indian firms with a China exposure. For instance, despite the robust surge in JLR vehicle sales in the US and Europe this fiscal, parent Tata Motors’ stock has been continuously underperforming benchmark indices. The overbearing concern for the stock seems to be JLR’s Chinese sales, which make up about 25 per cent of JLR’s total sales are now down to over ten per cent. On the macro front, the World Bank on Wednesday cut its global growth forecasts for this year and 2017, citing concerns over China’s slowdown and its impact on commodities that have been at the forefront of traders’ minds since 2016 got under way. Most analysts, though, contend that investors will find India attractive when the dust settles.
From an investor perspective, at least in the short-term, it might pay to stay off stocks with a high exposure to China as well as commodity-specific stocks, which could see volatility in the wake of the continuing turbulence in China in the weeks to come. Sectors such as textile and garments could see some turbulence. There could be concerns for banking sector stocks, who are already under pressure on account of a lingering bad loans problem. Also, firms that have seen funding from Chinese entities, especially in core sectors such as power, could experience some volatility from a stock perspective. Sectors where the burden of debt is high — including iron and steel, construction and telecommunications —could also see continued selling pressure in the coming months. The adverse economic developments may have a directionally negative impact on the Indian metals industry as well as on sectors with an export focus, India Ratings and Research (Ind-Ra) said in a recent report.
The circuit breaker and other market interventions were announced by Chinese authorities in December after a continuous string of stock market slides. The circuit breaker, which was put into use for the first time on Monday and then again on Thursday, automatically stopped trading in stock markets if indices dropped or appreciated too sharply. While they had been presumably introduced to curb panic buying and selling, analysts were of the view that these measures only added to selling pressure the next day. Late on Thursday, Chinese securities regulator announced a suspension of this newly-installed circuit breaker.
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