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Demystifying The Chinese Dragon

Monday, January 11, 2016

As stock markets across the world go into a tailspin after China concerns rise, there are various views, most contradicting each other. While some believe that the markets have over-reacted, others believe that the worst has yet to unfold. The questions that arise are: Will the Chinese economy face a hard landing or will the transition of rebalancing of China's economy be a smooth one? How will it effect the Indian economy? Harsh Kundnani analyses the unfolding events of the past few weeks including the Chinese data numbers, global markets and comes to the conclusion that while India's fundamentals remain sound, the stock markets could witness bouts of very high volatility over the near term

As the world economy has been in turmoil and slowdown concerns prevail in the Eurozone area, plaguing the rest of the nation’s along with, the only bright spots in the past few years have been China and India. China has been in the forefront of world growth since a number of years and given it’s the world’s second largest economy by nominal GDP, its impact on the world economy cannot be questioned.

Nevertheless, the global scenario is experiencing major tectonic shifts in the financial sense. After witnessing decades-long multiple digit growth, the Chinese economy seems to be running out of steam as it posted 7.7% in 2013, 7.4% in 2014 and a mere 7.0% in the first quarter of 2015
The Chinese economy is a double-edged sword, one that is out of control of investors. However, as many economists claim that 2016 will be determined by the events in the Chinese financial world, and as the Chinese economy shows clear deceleration, it is imperative to understand whether the Chinese economy will face a Hard landing or will the transition of rebalancing of the economy be a smooth one; and its effect on the Indian economy.

The Chinese economy is touted to grow at a rate of 7.0% in 2016 and 6.9% in 2017, as reforms are being enforced designed to shift the country away from building infrastructure to a consumer spending powerhouse economy. While the aforementioned rates are considerably lower than the double digit growths it has posted in recent years, it, by no means justifies the sharp sell-off we have witnessed in the Chinese markets in the summer of 2015 as well as in the past week.

The lower circuit in the Chinese market, which was triggered twice in the past week was initiated by the reports of Caixin/Maikit survey of China’s Purchasing Managers Index (PMI) data reported that China’s manufacturing had slowed down to a PMI of 48.2, causing a panic in the stock markets as well as the commodity markets causing the Crude Oil to lose a staggering 10% in just one week and causing a drop in prices of other commodities too. Some experts also blamed the flawed circuit breaker, which was recently implemented by the Chinese authorities

. A global sell-off was witnessed on Thursday after the aforementioned incidents and after People’s Bank of China set the Yuan’s reference rate at 6.5646, the lowest levels since April 2011. The China Securities Regulatory Commission, post the activation of trigger consecutively on Wednesday and Thursday, suspended the Circuit Breaker mechanism. While this might prima facie seem that the markets might go into a freefall without any mechanism to support it, many experts believe otherwise.

The removal of the Circuit breaker re-instils faith in the economy and at the same time addresses the important issue of uncertainty; by not leaving the amount of downside potential to the assumption of investors. By all means, the China market looked to be oversold and that was clear by Fridays performance as China closed up almost 2% while the rest of Asia too regained some of the lost ground.

All these incidents have given us one thing to take away; which is that volatility is here to stay, at least for the near future. Shifting our focus back to our home soil, we could witness sharp sell-off and equally resilient recoveries on the markets, amidst the global turmoil, given that in the short run India is not impervious of spill-offs from the global turf.

However, the fundamentals of India are unchanged. Also, any decrease in global commodity prices will only benefit India, as we are net importers of commodities.India is well on its way to become the global hub for manufacturing and the governments primary focus is to develop India on the economic front. As long as it taps its potential correctly and parries off any potential negative effect of China’s slowdown, we could see a shift in Asia’s regional power structure in the years to come.

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