How China Has Transformed Over The Years And Why Is It Important For Us

After implementing free market reforms in 1979, China bounced back and parted ways with poverty, stagnation and centrally-controlled working style. The growth history of this giant mammoth, since then, has been marvellous. It has now become world’s largest manufacturer, merchandise trader and holder of foreign exchange reserves. The real per capita GDP of China has grown from $1740.09 billion in 2006 to $3865.881 billion in 2015. From being one of the largest contributors to global economic growth, China has moved on to become one of the largest contributors to the global recession.

The problem with China started post 2008 financial crisis. Since then there has been a lot of ups and downs in the Chinese economy which has led to downward trend in its economic performance. It is currently undergoing major challenges and transformation.

The major paradigm shift, obviously in the negative light, happened when the government took huge debt to invest in the creation of ghost towns which later faltered as houses were lying vacant and idle. Banks that had invested in this high-profile housing plan suffered the most as loan repayment became an issue. China’s surging debt levels became a cause of worry.

Property investment hence weakened as price increases began to slow after more than a decade. To curb this problem, the government there focused on infrastructure investment like spending on roads, railways and sewage systems etc which is still finding ways to support the economy. Investments in new factories have also weakened due to exorbitant interest rates and scarcity of loans. This has turned the financing of everything from raw materials to equipment difficult challenge for businesses and individuals without political connections. Moreover, rising wages and shortage of labourers have begun driving some industries offshore which has further crippled the economy.

Exports and imports have taken a beat too as slowdown in the global economic growth has affected the consumption pattern of people. Weaker domestic consumption of China has hampered the imports too. With downbeat market conditions and a softer client demand, the overall manufacturing sector of the dragon nation has declined.  Moreover, relations between China and its trading partners have been strained due to its piracy of goods. This prompted other nations to tighten the antitrust regime against China.

To change the economic model so as to revive its sluggish economy, rebalancing of growth from investment to consumption and from industry to services was undertaken. This worked in its favour for the first time in July 2015 as demand for new order accelerated to a solid pace that was the second-fastest in eight months. However, from macro-view the economy still suffers from deflationary pressures owing to unsatisfactory inflation rate.

The GDP Annual Growth Rate has fallen from 7.9 percent in 2013 to 6.9 percent in 2015 which was weakest in the last 25 years. Moreover, the IMF has projected China’s real GDP growth to slow down further at 6.3 percent in 2016.

In stark contrast, the Chinese stock markets surged by a massive 150 percent (June’14-June’15) in the face of a slowing Chinese economy mainly led by margin trading boom. A big reason for this rally was that a lot more people started buying stocks with borrowed money. However, this joy-ride did not last for long. 

On 12th June’15, the government came up with the toughest measures and announced a new limit on the total amount of margin lending stock brokers could do, while also reiterating the ban on illicit margin trading through mechanisms like umbrella trusts. This sudden development created a rout in the Shanghai Composite Index thereby bringing the market's total losses to 32 percent in less than a month (July’15) and pulled other global markets in its vicious circle.
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The Shanghai crash is not the only surprise element here. Another outrageous move by the Chinese government on 12th August’15 was the second Yuan devaluation since 1994. Earlier big state-owned banks used to submit their Yuan-Dollar prices to the People’s Bank of China which was later averaged out to calculate a “central parity” rate. The Central Bank thereafter used to intervene to keep the exchange rate from straying more than 2 percent above or below the midpoint. However, now the midpoint would simply be market-based i.e. the previous day’s closing value. The Chinese currency thereafter dropped as much as 1.99 percent on the very first day post devaluation.

Reason behind this devaluation was to boost sluggish exports and to include the Chinese currency in SDR by the IMF. SDR is a basket of currencies used by the IMF as its unit of account. To bring the Yuan in to the SDR, the IMF asked China to make changes to its currency regime and make it freely usable. Hence, the People's Bank of China (PBOC) came under pressure to manage its currency like other the central banks in most rich economies and let the market forces determine their value. IMF has included the Yuan in to basket of currencies joining the dollar, the euro, the pound and the yen.

The start of 2016 has not been in favour of the giant mammoth too. The Shanghai Composite Index crashed again after China’s central bank lowered the Yuan’s reference rate by the largest margin since August’15. This infused fear in the minds of investors that the Chinese government is using a weaker currency to spark growth for an economy that is struggling more than expected. To prevent the Shanghai Composite Index to fall further, the Chinese regulators halted trading by installing ‘circuit-breakers’ when the market reached a low point.

In broader perspective, China - the world’s second largest economy, has been going through a bad phase that shows no signs of ending. Furthermore, the SOS measures that the Chinese government is implementing aren’t working either. This will keep all the global investors on their toes, as this to some extent, will impact the world economy.