16 February 2019
A renminbi devaluation is the quickest, most effective way to perk up the economy amid lackluster global growth. Photo: Bloomberg
A renminbi devaluation is the quickest, most effective way to perk up the economy amid lackluster global growth. Photo: Bloomberg

China should stimulate the economy, not the stock market

China has employed various monetary easing measures, but they have failed to stimulate economic growth.

It may need to use fiscal policy, such as increasing debt leverage as done by the United States and Japan. 

We believe the Fed may not hike interest rates this year even if its economic growth picks up. The US now accounts for only 20 percent of the global GDP, while the rest of the world is suffering from sluggish equities, currency and economy.

The Fed “lift-off” is aimed at proving that the US economy has normalized after more than eight years of quantitative easing. But going ahead with the tightening cycle could trigger serious turmoil in the financial markets.

The moderating economic growth in China, the long-time growth engine for the global economy, is affecting various industries and the consumption of goods worldwide, including luxury goods, daily necessities, property, industrial goods, technology products and commodities.

As such, the renminbi devaluation can achieve multiple goals.

First, it is the quickest and most effective way to perk up the economy amid lackluster global growth and deflationary pressures, as shown by Europe and Japan.

Second, as the world’s second-largest economy, China has paid a heavy price to maintain its exchange rate in a responsible manner. However, the Fed has ignored the economic woes and deflationary pressures in other countries, and has insisted on sticking to its own economic cycle.

Thus, Beijing sees it fit to weaken its currency to tell Washington that it should act responsibly as the world’s largest economy.

Third, many Southeast Asian countries like Vietnam and the Philippines, because of the support of the US and Japan, have been challenging China

A sudden yuan devaluation serves as a warning. These nations have been using cheaper labor to compete with China. The labor cost in Vietnam is only a fourth of China’s.

China could regain its status as the world’s manufacturing powerhouse if Beijing lets its currency fall deeply like other currencies in emerging economies. China also has complete industry chains and various infrastructure facilities as well as a massive domestic market.

Fourth, if China weakens the renminbi by 40 or 50 percent, that could create an economic disaster for Southeast Asian nations. Vietnam, Malaysia and even Kazakhstan have followed suit after China’s devaluation of its currency.

Beijing should have adopted the double-barreled easing shot much earlier, but that could raise fears of further yuan devaluation and stir up other emerging markets.

Nevertheless, the move could boost domestic demand and also the broad economy.

It could also mitigate deflationary pressures and economic growth issues across the world.

If China continues to adopt such a tack, weakening the renminbi further, will that worsen the currency war and lead to a global equity market meltdown?

China planned to use financial reforms, the “one belt, one road” initiative, and the Asian Infrastructure Investment Bank to tackle a number of issues like excessive capital, overcapacity and oversupply.

Beijing hopes to lower financing costs through the financial market, while the US and Japan are pushing the Trans-Pacific Partnership and oppose the inclusion of the renminbi in the International Monetary Fund’s Special Drawing Rights basket as well as the A shares in the MSCI emerging markets index.

In view of rising protectionism in the world, China has encountered setbacks in pushing financial reforms and its “one belt, one road” strategy has progressed slowly.

It has to weaken its currency given its sluggish economic growth and gloomy equity markets.

The Hong Kong market cannot be unaffected and posted a deep correction recently. Many stocks with healthy earnings also suffered from the market crash. China Mobile (00941.HK), Tencent Holdings (00700.HK) and some utility plays fell.

The market is likely to bottom out after US market or stocks with solid fundamentals find the floor.

The Chinese government has already suspended its costly market rescue measures, and switched to monetary easing and fiscal policy to boost the economy.

This would in turn restore market confidence and stem the market slide. Investors could consider collecting stocks gradually given such attractive valuation levels.

This article appeared in the Hong Kong Economic Journal on Aug. 27.

Translation by Julie Zhu

[Chinese version中文版]

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Founder and Managing Director of Pegasus Fund Managers Ltd.

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