The ripple effect of increased uncertainty over the China outlook
Valentijn van Nieuwenhuijzen (pictured) is head of Multi-Asset at NN Investment Partners.
The ripple effect of increased uncertainty over the China outlook is not only impacting many other emerging market economies.
It is also a key driver of supply-demand expectations in commodity markets and is taking its toll on many other parts of the global economic system.
Asset prices related to the energy or materials sectors, or to export-oriented regions in developed markets, like Germany or Japan, remain especially sensitive to shifting expectations about China’s future.
The most fundamental challenge to the outlook for China and EM is the dangerous cocktail of a remarkably persistent decline in growth momentum and the lingering lack of structural reform.
The growth weakness is partially a consequence of the macroeconomic imbalances that have built up in the EM region, specifically; excess credit that now needs to unwind.
These same imbalances have meanwhile increased the urgency to act on the reform front.
Reform action is obviously needed in a broad range of areas. Readjusting an export-oriented growth model to make it more focused on consumption and the service sector, improving the institutional fabric by reducing clientelism and increasing the independence of policy-making, enhancing competiveness in product and labour markets and reducing rent-seeking opportunities through effective oversight and regulation are some key elements of the EM reform menu, but different meals might have to be served in different countries.
In China’s case a lot of the reform ingredients will have to be used to solve all of its current economic challenges, but policy-makers’ fading credibility seems to have fuelled the fire recently.
Against a backdrop of fundamental fragility, market perception of policy-maker credibility can be a key swing factor because it strongly influences the risk of negative feedback loop from markets to the underlying economy.
Once FX, bond and equity markets start selling off because of falling policy-maker credibility, Chinese/EM financial conditions will tighten and add additional headwind to the growth outlook.