Wednesday, September 2, 2015

Stimulated growth comes to an end in China

The slowdown in China was postponed for several years in a row by its Govt. and central bank’s efforts.

When the China’s steel factories were massively underutilized, its Govt. stepped up public spending but with a deficit in revenue so it was borrowed spending. It built roads to nowhere and towns loved by ghosts. So it's public debt grew from 35% of GDP to 41% now. How the Govt. has to repay this debt? It can’t raise its taxes and the projects it took are not paying back either. This ballooning debt will have an impact in the budget of coming years. Increasing capital costs but stagnant or reducing revenues would result in reduction of Govt.’s effective spending too in the coming years.

Similarly, it s central banks made its moves too. It devaluated its currency, reduced interest rates, cash reserve ratio in its banks etc. to ensure money reached the markets at low capital costs. In simple words, it employed larger capital to get lesser growth. Its private debt too grew producing the physical capital which does not have many takers. Then what will happen to corporate profits? Why stock market will go up when profits are not?

Economies or markets cannot go always in one direction. What can go up, can go down too. Take a look at China’s stock market. What a volatility it had witnessed! Despite many measures took by its Govt., investors just rushed to take their money somewhere else. Take a look at other measures such as exports or PMI data. They are clearly pointing toward a cooling down economy.

It is not end of the world. But if China tries some more stimulation, its debt will grow further. If it stops stimulation, economy will suffer. If they (Govt. and central bank) stop interfering, defaults will loom and put China in recession. So they will not let it happen by reducing regulation. Accepting a slower growth seems to be a logical step than increasing incentives which can be suicidal. While only China knows what are its plans, be prepared to see around 5% growth numbers for their GDP for many years to come.

A slowing down China will shrink global trade. Commodities are already hit badly as China reduced its imports. Those natural resource selling countries will have to tighten their budgets so will see a slowdown in their GDP growth. Apple will not be able to see the expected growth in their sales of smartphones in China. When tech companies in US control their IT spending, India will suffer. Weaker currencies in emerging countries will hit their import spend. All this will lead to shrinking global trade and a slower global GDP growth.

Slowdown in China may not be the last one. US Fed, the biggest stimulator, is on its way to increase rates. That would mean corporate profits in US will be in check and the ability of Govt. to increase spending would not remain. This will act as a resistance to the recovering economy of US. Though its central bank will act in a controlled measure, what lies ahead is, US GDP may not see higher growth than now.

This year it is China. Next year it will be US and the following year it could be Europe getting out of stimulation. Stimulated growth will come to an end all over the world putting pressure on all economies all over the world before they return to a normal course.

India is not affected the same way as we do not have much stimulation except letting our currency weaken. But yet, we (India) should stop talking 10% growth for another two years. And become more realistic.