Op-ed: Biggest Threat from China Slowdown is a US Overreaction

By Sharmin Mossavar-Rahmani
Financial Times 
January 28, 2016

Concern about the slowdown in China's economy and Beijing's tenuous policy responses have been the primary driver of the past two big slides in global equities. Throw in the uncertainty about what Saudi Arabia might or might not do to stabilise oil prices , and investors should brace for extreme volatility in markets.

This volatility reflects an overreaction to the slowdown in China , but the absence of a clear strategy for the devaluation of the renminbi has not helped. What was billed as a one-off currency change last August has morphed into a series of depreciation measures against the US dollar.

China is undergoing significant transition. It is attempting a shift away from an export-driven and investment-led economy to a more balanced, consumption-oriented one. To achieve its goals and double gross domestic product and GDP per capita by 2020 from 2010 levels, the leadership has set out an extensive reform agenda. This includes further financial market liberalisation and state-owned enterprise, fiscal and rural land reform. Such widespread transition brings risks and significant uncertainties. A complex and interconnected reform agenda has never been achieved on this scale or at this speed.

China is walled in. If reforms are implemented too quickly, it risks a sharp slowdown. If they are implemented too slowly or not at all, it risks an unsustainable increase in debt-to-GDP ratio, which could push the country past the tipping point into economic and, in all likelihood, political instability. Beijing is also constrained by deep structural faultlines, including weak demographics and low rankings on human capital factors such as tertiary education, labour productivity and business environment indicators.

These challenges are being faced against a backdrop of modest projected global growth of about 3 per cent in 2016.

At first glance, investors may think such a backdrop warrants the recent market downdrafts . US markets, however, are overreacting to the slowdown.

Yes, China is the second-largest economy, generating 12.7 per cent of global exports and 10.4 per cent of imports. And its demand accounts for 50 to 60 per cent of the production of iron ore, nickel, thermal coal and aluminium, and a significant share of copper, tin, zinc, steel, cotton and soyabeans.

But China is not the "next subprime crisis". Why? First, while confidence in the latest published GDP growth of 6.9 per cent is limited, more widely accepted indicators do not portend a collapsing economy. The Goldman Sachs China Current Activity Indicator and Emerging Advisors Group China Activity index show growth of 5.2 per cent and 6.1 per cent respectively.

This growth is driven by consumption-oriented sectors such as retail and travel.

Second, given President Xi Jinping's remarks that the GDP growth rate "should be no less than 6.5 per cent in the next five years", policymakers will use all available tools to try to reach such targets.

Third, the US does not have significant direct and indirect economic and financial exposure to China. The US exports 0.7 per cent of its GDP to China. US banking sector exposure is 0.8 per cent of bank assets, compared with 39 per cent exposure to US mortgages in 2007.

According to US national income accounts, only 0.7 per cent of US profits are sourced in China. Goldman 's global investment research division estimates a 1 per cent drop in China's GDP growth will have a 0.1 per cent impact on US GDP, including indirect exposure.

The greater impact will come from financial contagion. If markets overreact , the drop in US GDP growth could increase to 0.47 per cent. Similarly, the International Monetary Fund's 2012 Spillover Report estimated that a 1 per cent slowdown in China's GDP would lead to a 0.05 per cent slowdown in global growth - compared with 0.3 per cent from a 1 per cent US slowdown.

More consistent and transparent policy with respect to the near-term strategy for the renminbi is critical to stabilising markets and ultimately to China's reform agenda, given the continuing reliance on exports to boost the economy and foreign currency reserves. But China's impact on markets is overstated.

Sharmin Mossavar-Rahmani is chief investment officer of Goldman Sachs Private Wealth Management Group