China and emerging markets
There are signs of progress.
As we discussed in a paper that we released in October 2016, “Why is China important to UK investors?”, policymakers in the world’s second-largest economy are shifting the focus from manufacturing and export-led business to services and domestically focused sales. An essential part of this transition is dealing with state-owned enterprises many of which are unprofitable, saddled with debt and only able to exist due to government-sponsored subsidy.
There are signs of progress. Banks have raised capital enabling them to write off some of the non-performing loans, and the government is planning to increase welfare provisions. The latter point would make job losses from corporate reform less painful while also reducing the incentive of individuals to put such a huge proportion of what they earn into savings, and that reduced propensity to save would increase spending and boost economic growth.
If policymakers can push reform through and reduce the presence of state-owned enterprises, then the capital that has been used to prop them up would become available to more efficient and commercially viable enterprises, which is exactly what China needs. And with the prominence of international trade in the global economy, Chinese economic growth is very likely to translate to global growth.
In the meantime, there is a further issue relating to central bank policy and the value of the Chinese currency, the yuan. Chinese banks have lent huge amounts of money out and this has contributed to there being, in effect, too much cash sloshing around the Chinese system. Companies and investors have sensed this and that it is likely to lead to the value of the yuan falling. Therefore, many of them have been moving money out of China. Nonetheless, further devaluation of the yuan is likely and that has implications for the global economy. For example, the lower the value of the yuan, the cheaper Chinese exports are overseas, and the harder it could become to compete on price with Chinese products.
The Chinese central bank is focusing its efforts on the control of interest rates and restricting the flow of money out of the country. The extent to which it succeeds will be closely watched from across the global economy.
Looking beyond China, there are some positive signs developing in other emerging markets. The latest purchasing managers index (PMI) surveys (which indicate the potential for future growth) suggested that the economies of Russia and Brazil might have turned the corner and could even be out of recession by early 2017.
In Asia, PMI surveys were among a range of positive data suggesting that these countries might be in a position to tackle low productivity levels and a labour force that no longer has the capacity to grow at a fast rate and thereby keep wage costs down. Other positive data include the improvement of company balance sheets wherein debt levels have been reduced and cash-flow increased, though this improvement has not always been reflected in equity prices making some shares potentially attractive.
A possible weakness for the region could include a sharp downturn in the Chinese economy, though the region is currently benefiting from measures being implemented by the Chinese central bank to stimulate its domestic economy. However, the future became more uncertain after the election of a US President who has spoken about imposing import duties on China and suggested that some of the Chinese actions could be construed as currency manipulation . On balance, though, with global interest rates looking likely to stay low for the time being, the outlook for emerging markets, especially in Asia, remains positive.
 “What will a Trump presidency mean for China?”, National Public Radio website, 10 November 2016.
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