Even though Asian markets popped higher overnight, this does not deter from the question: is China in slowdown, or is it a meltdown?
A recap of what has happened so far. China had a shaky start to the year with plunging stock prices. The turmoil in Chinese stock markets led to stock trading being suspended twice last week, on the back of a newly-introduced "circuit-breaker" mechanism.
At the same time, Asian bondholders are spooked. Bloomberg reports the cost to hedge against non-payment of debt in Asia soared in January.
Meanwhile, China's currency, the renminbi, has depreciated over the past months, fueling much of the turmoil. And though the depreciation is small compared to other currency's movements, many still fear that the renminbi will be devalued further and thus steal growth from other countries.
And there are other factors. China is on a long-term declining growth trend due to demographics and to a natural slowdown as its economy matures. The past growth of China of 8-10% per annum was robust, but not unusual compared to markets like Japan, Korea and Taiwan when these countries were in their strong growth phases. Real GDP growth from 2016 to 2020 is projected at around 6.5%, according to the 13th Five Year Plan. Given that industrial production growth is currently 6% year-over-year and after-inflation retail sales are over 11%, this forecast seems reasonable.
The latest key risks include over-capacity, a large housing inventory and high corporate debts. Reducing the excess capacity will require a slower growth rate, for example through the foreclosure of properties and closing or sale of excessively-leveraged, state owned enterprises. China has been choosing a gradual approach to solving these problems, but the longer the adjustments take, the higher the risk of mismanagement or economic crisis.
As we outlined in our Global Economic Outlook last week, Chinese monetary authorities are attempting simultaneously to loosen capital controls, sustain economic growth and control market stability. Given its current economic structure, this is an impossible feat and a sure recipe for more market volatility this year and next as occasional, and inevitable, policy missteps are made. Ultimately, China still has about USD 3.3 trillion of reserves to throw at any problem, so the risk of a hard landing (a sharp drop in growth of 3 to 5%) is 20%. This is high, but only 20% because the situation is manageable.
And it is manageable because many things are going well in the Chinese economy. Monetary policy is very loose, credit expansion has slowed – but continues, and the new two child policy will ease demographic pressures a bit. The renminbi has been included in the IMF currency basket, which will increase demand for it as a reserve currency, and its mild devaluation will boost exports modestly.
Most likely, the world economy will muddle through the next couple of years and grow moderately, providing a boost in demand for insurance as economic activity increases. Nevertheless, for now, insurers and risk managers must monitor the risk of a hard landing in China, because it is still the greatest risk to global economic growth. Additionally, a contagious financial crisis in other emerging market crisis also warrants watching. A world financial crisis is possible – but unlikely – so business as usual with an emphasis on increasing the demand for insurance through education about its usefulness and providing new products for new and existing risks will be a recipe for success for the industry.
Category: Funding longer lives, Other