China's slowing economy: What's wrong and why it matters

The slowing of China's economy has resulted in financial markets tumbling.
The slowing of China's economy has resulted in financial markets tumbling.PHOTO: REUTERS

SHANGHAI (AFP) - Asian stocks nosedived on Monday (Aug 24), led by sharp falls in Shanghai as concerns mount over the health of China's economy - the world's second largest.

Although China, a major engine of global growth, has been slowing for some time, financial markets have nevertheless tumbled over fears its economic growth will decelerate faster than expected.

Here are answers to key questions on the Chinese stock market and the wider economy:

What has China done to try to stop shares falling?

China rolled out a range of measures in July after Shanghai stocks slumped more than 30 per cent from their mid-June peak, but while they had a short-term impact in buoying prices, their impact has since evaporated.

Shanghai's benchmark index rose about 17 per cent in the two weeks following the measures' announcement, but have lost all of those gains, and then some, to fall nearly 21 per cent since.

In the early July moves, the government intervened with a rescue package that included funding the state-backed China Securities Finance (CSF) to buy stocks on behalf of the government.

Other measures include barring "big" investors from selling their stakes and cracking down on short-selling - when investors bet prices will go lower.

At the weekend, the authorities said the state pension fund would be allowed to invest 30 per cent of its total assets - which according to the official Xinhua news agency amount to 3.5 trillion yuan (S$780 billion) - in shares.

In an effort to reassure investors that intervention would continue, the market regulator said the CSF would keep stabilising the stock market for a number of years.

Beijing has also cut interest rates and issued a shock devaluation of its currency of nearly two per cent on Aug 11, causing the yuan to tumble almost five per cent over that week, which should give exporters a boost.

Where next for China's stock market and currency?

Monday's falls take the Shanghai stock market below its level on July 8, when Beijing stepped in and prompted a rally. It is also below its closing level on Dec 31, 2014, meaning it has wiped out all its 2015 gains.

Despite the government's "national team" having made a major effort effort to support the market, analysts say shares are likely to go still lower as the plunge in global bourses is blowing back on China in what is effectively a vicious circle.

The yuan is widely expected to weaken further against the US dollar, although the central bank is expected to intervene to prevent steep slides. Japanese bank Nomura expects the currency, currently around 6.4 yuan to the US dollar, to depreciate further to 6.6 by the end of the year.

Why are financial markets so gloomy about the Chinese economy?

China's economy expanded 7.4 per cent last year, its weakest since 1990, and growth has slowed further this year, measuring 7.0 per cent in each of the first two quarters.

It is a far faster growth rate than most other major countries, but the yuan move raised suspicions that the state of the economy is worse than officials have revealed.

China's second quarter gross domestic product (GDP) figure exactly met the government's full-year target of "around" seven per cent, leading some analysts to question the announcement, which came after several weak indicators. China has long faced accusations that the government massages economic figures during times of slowdown.

Why is slowing growth such a problem domestically?

Experts say China's ruling Communist Party needs to deliver improved living standards, lifting more people out of poverty and satisfying the growing middle class, in exchange for acceptance of its rule. The government also needs to maintain a minimum level of economic growth, which some analysts put at seven per cent, in order to create jobs for millions of people and prevent social unrest.

Why is slowing growth a problem internationally?

With Europe's economy weak and the US preparing to raise interest rates, the world has looked to China's thirst for raw materials to keep finances humming. With more than 1.3 billion potential consumers, the country is also a big market for manufactured goods such as cars. Any weakness in demand could be keenly felt by producers.

Is the panic justified?

Analysts are mixed on the question. The latest scare came last Friday when a survey indicated that manufacturing activity was at its lowest for more than seven years.

"The multi-year low in the PMI (purchasing managers' index) confirms that the economy is still not on a solid footing and (we) look for a flat growth profile in H2, with continued downside risks," Barclays Bank said in a research note.

But others said China can still deploy further interest rate cuts and spending measures.

"We continue to believe that sentiment is currently overly downbeat and that policy support will limit the downside risk to economic activity over the course of the next couple of quarters," Capital Economics said.

Another risk is that market interventions could derail economic reforms and cause the government to fall back on pump-priming instead of pursuing its long-touted aim of shifting to domestic consumption as the driver of more sustainable growth.