Last week’s announcement that China’s GDP grew at an annualized rate of 7.4% in the first quarter of this year has stirred speculation about that country’s economy. Some are skeptical of the data, and point to other indicators that suggest slower growth. Although a deceleration in growth is consistent with the plans of Chinese officials, policymakers may respond with some form of stimulus. Their decisions will affect not just the Chinese economy, but all those economies that deal with it.
The latest World Economic Outlook of the International Monetary Fund has a chapter on external conditions and growth in emerging market countries that discusses the impact of Chinese economic activity. The authors list several channels of transmission, including China’s role in the global supply chain, importing intermediate inputs from other Asian economies for processing into final products that are exported to advanced economies. Another contact takes place through China’s demand for commodities. The author’s econometric analysis shows that a 1% rise in Chinese growth results in a 0.1% immediate rise in emerging market countries’ GDPs. There is a further positive effect over time as the terms of trade of commodity-exporters rise. Countries in Latin America are affected as well as in Asia.
These consequences largely reflect trade flows, although China’s FDI in other countries is acknowledged. But what would happen if China’s capital account regulations were relaxed? Financial flows conceivably could be quite significant. Chinese savers would seek to diversity their asset holdings, while foreigners would want to hold Chinese securities. Chinese banks could expand their customer base, while some Chinese firms might seek external financing of their capital projects. A study by John Hooley of the Bank of England offers an analysis of the possible increase in capital flows that projects a rise in the stock of China’s external assets and liabilities from about 5% of today’s world GDP to 30% of world GDP in 2025.
While the study points out that financial liberalization by China would allow more asset diversification, it also acknowledges that world financial markets would become vulnerable to a shock in China’s financial system. Martin Wolf warns that the down-side risk is quite large. He cites price distortions and moral hazard as possible sources of instability, as well as regulators unfamiliar with global markets and an existing domestic credit boom. Similarly, Tahsin Saadi Sedik and Tao Sun of the IMF in an examination of the consequences of capital flow liberalization claim that deregulation of the Chinese capital account would result in higher GDP per capita and lower inflation in that country, but also higher equity returns and lower bank adequacy ratios, which could endanger financial stability.
There could be another result. A sizable Chinese presence in global asset markets would lead to even more scrutiny of Chinese monetary policy. A policy initiative undertaken in response to domestic conditions would affect financial flows elsewhere, and foreign policymakers most likely would voice their unhappiness with the impact on their economies. The Peoples Bank of China, accustomed to criticism from the U.S. over its handling of its exchange rate, might find the accusation of “currency wars” coming from other emerging market countries. The price of a successful integration of Chinese financial markets with global finance will be calls for more sensitivity to the external impacts of domestic policies.
If other countries complain about the impact of Chinese monetary policy on their economy, the Chinese could do what we do–remind people that monetary policy is geared towards domestic concerns. Our policymakers didn’t react kindly to Raghu Rajan complain about the impact of tapering on emerging countries. WSJ reported that Ben Bernanke confronted Rajan in a recent conference at Brookings.
I would be surprised if China liberalized its capital account without making its exchange rate more flexible. Many Chinese policymakers have expressed interest in greater flexibility, having already widened the RMB by +/- 2% earlier this year. Given how skittish they are about hot money flows destabilizing their economy (as evidenced in the PBOC’s devaluation of the yuan in response to speculators betting on the yuan’s appreciation), it would make sense for them to simply float their currency so that the exchange rate can act as a shock absorber.
I actually think that China is less likely to face accusations of a currency war if it were to liberalize its capital account, since it would most likely need to make its exchange rate more flexible to preserve monetary autonomy. That being said, emerging markets have interpreted Bernanke’s quantitative easing as a currency war of competitive devaluation, so I suppose anything’s possible!
The China’s GDP growth rate of 7.4% can be susceptible because there might be evidence of recent relatively small-scale on expansion of the Chinese market. China’s GDP grew rapidly in the past years because first, it has a small base number which is no longer small recently. Second, China’s GDP depended so much on the housing market from 2006. During the 2008 global financial crisis, China kept on its growth rate because of the rapid increase of housing price in its major cities. However, since the political (one party) influence on the public data is so great that ordinary people and even some economists may be confused by it. I hope that there will exist some study on these data which may lead to a closer estimation of the real growth rate in China.
Although I’m not surprised analyst are skeptical about the GDP growth data, it seems consistent with the Reuters poll for example, and the recent sluggish trend. The financial sector seems mostly concerned with what any kind of intervention (whether monetary or fiscal) would mean for the Chinese economy and for the investors. When Chinese authorities make the decision to stimulate the economy, it will be a sign of the true state of the economy and there could be a rapid withdrawal of funds – therefore, I don’t see Chinese leaders making the decision to deregulate capital flows quite so soon as I am sure they expect this form of instability. China is, and will continue to be, a major player in the global economy; as they continue to be vital for the stability of the rest of the economies, I would say they would have even more caution with any decision.
At a point in time in which some are dubbing China as the no.1 Economy in the world (when taking into account purchasing power parity), I wonder how China would continue to achieve the delicate balance of Mundell’s theory of policy trilemma. The Aizenman, Chinn, and Ito (2012) paper talks about how EMEs like China are convering at the “middle ground” of the trilemma by having a managed exchange rate flexibility cushioned by large amounts of foreign reserves, and moderate levels of capital liberalization and monetary control. Are today’s rising economies structured so differently that they are setting a new configuration of macropolicy combinations or will a negative shock such as the supposed Chinese real estate or lending bubble pop force China or other EMEs forgo one macropolicy to regain stability in the other two?
In continuing to explore each country’s macro policies and what influences them (in our class and beyond), I have ultimately realized that each country will always prioritize itself in its decisions, no matter how globalized the financial system. China is a key example of this. This is a country that has taken advantage of the positive aspects of globalization (e.g. financial liberalization) to the benefit of their economic growth, BUT in their own sweet time. Likewise, China’s monetary policy is also an effective strategy that the country has used to support growth — regardless of all the criticism they have received, mostly from advanced economies — they prioritized their people first and it has been rewarding. Dani Rodrik, at Princeton’s Institute for Advanced Studies, pushes for African countries to follow in China’s footsteps in paving their own growth path — a path that consists of increased state capacity in 1) devaluing the exchange rate and 2) increasing dialogue with the private sector. No matter how much critics cry foul and accuse of ‘currency wars’, as it’s seen in the tapering of QE in the U.S., every country to itself.
China’s economic growth, financial liberalization, and general integration into the global economy has several downsides even aside from stronger global scrutiny of Chinese monetary policy.
As China continues to grow and integrate itself into the world economy, it will inevitably assume the status of a “developed” country, rather than an “emerging” one. This new prestige comes with responsibilities that China may not want to to take on at this time. For instance, other countries and western institutions may increase the pressure on China to undertake financial sector reforms, or reduce its greenhouse gas emissions by cutting back on industrial production. It remains to be seen how long China will be able to escape such responsibilities and maintain emerging-country-status despite phenomenal its growth rates and increasing influence on foreign economies.