Given the complex supply chain and global liquidity web linked to China, which contributed 29% of world GDP growth last year, analysts live in perennial fear of understating Beijing’s role in driving global markets.
So, is it all China’s fault? That’s the question vexing market players as they mull the drivers of the latest FX sell-off in emerging-market (EM) deficit nations and the bear market in the MSCI EM, more generally.
As Euromoney has reported, a perfect storm seems to have triggered the latest plunge, though EM sentiment rebounded moderately on Wednesday after the Turkish central bank capitulated with massive hikes in benchmark rates.
Fears over monetary-policy incompetence in Argentina and Turkey, Fed tapering concerns, markets discriminating between deficit and surplus countries, and a re-assessment of growth models, more generally, are, in part, to blame.
However, some analysts are tempted to pinpoint the catalyst for the sell-off squarely on China, where an investment slowdown has taken effect during the past three quarters, as Beijing squeezes out excess capacity and seeks to rebalance growth.
Lars Christensen, chief analyst at Danske Bank, and a monetary-policy blogger, goes so far in describing the EM rout as heralding China’s emergence as a global monetary superpower, akin to the Fed’s role as the driver of the dollar-led EM monetary system.
“The People’s Bank of China [PBoC] to a large extent has the same role – maybe even a bigger role for some emerging markets, particularly in Asia, and among commodity exporters. Hence, the PBoC can under certain circumstances ‘dictate’ monetary policy in other countries – if these countries decide to import monetary conditions from China.”
Christensen cites the complex China-linked exports web, the prospect of a reduction in Chinese reserves accumulation, and waning Sino-driven commodity demand, which, as a symptom of slower growth, is historically correlated with weaker Asian equity performance, despite the fact the region is a net commodity importer.
Nevertheless, as a proponent of market monetarism – arguing central banks should target the level of nominal income, instead of simply inflation or unemployment – Christensen reckons, in general, national EM central banks can offset Sino-driven monetary contraction.
However, others disagree over the extent to which China has driven the generalized EM sell-off thus far.
Arthur Kroeber, head of GK Dragonomics, notes: “We don’t buy that argument, but markets are driven by both fact and sentiment. At the level of fact, it is hard to construct a causal line running from China’s economy to the recent performance of EM stock markets.
“However, when it comes to sentiment, there is little doubt that many portfolio managers take weakness in China as a signal to cut their broad EM exposures.”
He cites the fact China’s investment-led slowdown is a clear negative for exports in markets such as Brazil and South Africa, but not for Turkey, Ukraine and Argentina, which have fallen the most for endogenous reasons.
Secondly, stock markets in commodity-rich nations have delivered mixed results, falling 7% year-to-date in Brazil, but still in the black in Indonesia and Thailand, and flat in China-exposed Philippines.
What’s more, while domestic liquidity is tightening in China – as authorities seek to engineer a softening of credit expansion, in the shadow banking industry, in particular – the PBoC has boosted the global money supply, through repressing upward pressure on the renminbi via massive US Treasury purchases.
During the past year, China FX reserves have risen by more than $500 billion, which is the fastest increase since mid-2011, according to BCA Research. By moderating the upward move in the global risk-free benchmark, China, in theory, has boosted investors' desire for EM yield.
Kroeber cites divergent stock-market performance in China- and commodity-linked Indonesia and Brazil as evidence of the importance of national policies, as the former is rewarded for efforts to develop a competitive manufacturing sector in contrast to Brazilian policy, which “has been little short of catastrophic in the last four years”.
In sum, Kroeber says: “The ‘China effect’ is bad for some emerging economies, but not as bad as Fed tapering and incompetent domestic policies. Well-run EM countries have plenty of ability to weather the storm. And China’s actual negative impact is likely to grow weaker, not stronger, over the next year.”
That’s not to discount the prospect that EM equity and fixed-income markets will continue to underperform this year, while macro noise – including the messy, last-minute rescue of a $500 million Chinese trust product this week – will frighten enough portfolio investors to ensure valuations overshoot fundamentals, say analysts.
Finally, to put the plunge in context: as this chart lays bare, EM hard-currency fixed income, in particular, is nowhere near 1998 crisis-era levels, while EM’s stronger macro fundamentals is well-known – two factors that have exasperated some analysts who decry apparently alarmist media coverage on the EM rout.