China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

The analysis of emerging markets is (partly) different

September 27, 2018

Many analysts think that the important country group of emerging markets currently is on the edge of a new crisis. May be – or may be not. We do not know yet – but increasing risks are certainly visible. Six of them are – or may be – most challenging. They are:

– domestic and global political risks, increasing protectionism included,

– rising interest rates in the U.S.,

– weakening economic growth in the advanced countries,

– contagion among emerging countries,

– increasing global risk aversion from OECD countries in emerging countries,

– accelerating psychological exuberance without consistent fundamental basics.

We have to recognize that emerging markets still depend to a high degree on developments in OECD countries – despite the fact that emerging economies already today have a higher share of global production (in PPP terms) than all the advanced countries (but with markedly lower GDP per capita than the first group of countries).

Special characteristics of emerging markets

Thus, the analysis of emerging markets must include developments in OECD countries but also certain own characteristics of emerging countries . If we watch these special characteristics from a risk perspective, factors like political and social risks, institutions, maturity of financial markets, economic reforms and stability in general terms play a particularly big role – mostly considerably more than in a mature country; this is, of course, exactly why we have this distinction between mature (advanced) and emerging countries.

The current account balance – often neglected by analysts

Sometimes also two other developments or indicators can become decisive for the development of an emerging market – the current account balance and foreign debt. In mature countries, these two economic indicators are not focused very carefully (with the Greek crisis a couple of years ago as an outstanding exception).

Normally, there are no particular analytical emergencies in this specific respect. But they occur. However, even professional economists appear sometimes very unskilled when it comes to knowledge and interpretation of current account deficits. This happens mostly when emerging countries are derailing.

Current account deficits mean that a country has more imports than exports of goods, services and cross-border financial transfers like the interest rate and dividend payments.

Unfortunately, the consequences of a substantial and persistent current account deficit sometimes turn out to be very negative. Of course, emerging markets can run limited deficits in cross-border business – may be up to 4-5 percent of GDP or so without any distortion; however, the internationally “accepted” upper limit is not static and certainly interpreted more strictly when the current account deficits worsen further and/or economic or political problems increase. At the end of the day, the international financial and non-financial community may lose confidence in the country.

In reality, a current account deficit reflects a negative national savings performance. This means a debt in foreign currency vis-a-vis-other countries. This negative outcome has to be financed by inflows of foreign currencies. This can happen by definition in three ways:

– foreign direct investments (FDI; if foreigners still are interested when problems increase sharply),

– borrowing money abroad,

– selling stocks and bonds to foreign portfolio investors (if there is a capital market in the emerging country) – which also may become a major risk when foreigners because of increasing doubts suddenly sell these papers again.

The case of a big crisis

It also happens that current account deficits develop into an alarming crisis. This may happen when simultaneously a credit bubble is bursting. Another critical development may show up when there is a major minus in the current account and foreign debt is high at the same time.

Even worse: when in such a situation with a very weak current account balance and high foreign debt a substantial part of this foreign borrowing is short-term based. Such a situation can aggravate further when also the affected country’s currency more recently has been weakening largely – which recently happened in Turkey. In this specific case, foreign debt grows further.

Adding, for example, in the analysis of Turkey’s substantial deficits in the current account the high amounts of short-term foreign debt, it is quite easy to understand the uncomfortable future risks of the Turkish economy.

Still a lot of work to do

Above, some of the above-mentioned risks demonstrate very well that the analysis of emerging countries may differ quite a bit from the analysis of mature countries. This concerns particularly institutions, the balance of current account and the amount and also structure of foreign debt.

This kind of necessary expertise cannot be achieved by occasional studies of emerging countries. Instead, a lot of regular and deepening research and analysis is needed (otherwise, no applicable or reliable forecast on an emerging market economy can be launched).

Unfortunately, we are still far away from ideal preconditions for the analysis of emerging market countries. A lot of more homework has to be done also in our part of the world.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board

 

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China’s statistical conundrums – the example of the PMIs

September 12, 2018

Surprisingly, one still can find people who believe that statistical quality in China has been improving in recent years. I myself cannot find evidence for such a conclusion, neither can our LNU China Panel (https://blogg.lnu.se/china-research/files/2018/05/ChinaPanelSurvey-May-2018.pdf ; at least there is no marketing or concrete information on such a desirable change coming from Chinese authorities. Still, there is a lot to wonder about.

One discrepancy that still makes me puzzled concerns statistics on GDP, industrial production and the Purchasing Manager Indices (PMIs). It may be added that I feel quite sure to understand the technical mechanisms of PMIs since I myself prepared and introduced the Swedish PMI almost 25 years ago together with my colleague Åke Gustafsson from Swedbank. Sometimes, statistical correlation between these micro and macro indicators is questioned ; and I myself – following my own historical experience – cannot either see sufficient consistency right now between the Chinese PMIs and Chinese industrial production or GDP – possibly or probably as a result of insufficient statistical quality rather than non-existing correlation.

Two PMIs in China

Let’s look at some numbers. There are actually two PMIs in China. One is produced by the National Bureau of Statistics (NBS) and the China Federation of Logistics and Purchases (CFLP) with focus on 3000-4000 larger companies including SoEs, the other one by Caixin/Markit with 430 private, mainly medium-sized and smaller companies. According to statistics for August 2018, the NBS/CFLP PMI for manufacturing rose slightly from 51.2 to 51.3 compared to the month before, whereas the corresponding Caixin/Markit index fell to 50.6 from 50.8. These numbers – not very far from the “borderline” of 50 between better and weakening growth – have been in these numerical regions for quite some time.

Abroad, the Caixin/Markit PMI tends to receive better recognition than the NBS/CFLP index because of no or only limited governmental influence. However, both indices are interpreted and commented very strictly when it comes to the borderline of 50. Just above 50 is usually regarded as positive and just below 50 as negative. But users of the PMI indices should be aware of the fact that both PMI series are calculated as diffusion indices that do not really reflect the strength of changes in the participating individual companies – and, consequently, only the direction. For this reason, I cannot warn enough for putting too much positive focus on numbers slightly above/below 50 and too encouraging/discouraging oral and written comments on further expansion or contraction. Some months of observation and/or moving averages could be useful.

It should be kept in mind that the Caixin /Markit PMI seems to be a notch closer to industrial reality than the official NBS/CFLP index – and, consequently, better capturing the currently fading export performance of Chinese industry.

Do Chinese PMIs reflect reality?

My view is that China’s PMI numbers during the past quarters have come in on (somewhat) too high levels. Again, a number not too much below 50 does not mean that a recession is going on – instead, for some time, only a declining rate of growth; and a number slightly above 50 does not necessarily point at an further improving industrial activity any time soon.

My strong feeling is that the real state of the Chinese industry seems to be (somewhat?) weaker these days than recent PMI indicators for manufacturing slightly above 50 may indicate. American protectionism hurts.

However, lagging transparency may mean that not all my conclusions necessarily are correct. One should be cautious and humble when interpreting Chinese statistics, also those for the PMIs.

Anyway, the globe’s second largest economy, China, still has a lot of institutional homework to do, improvements of national statistics included.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board

 

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“Hidden” leading indicators give reason for Chinese growth concern

August 20, 2018

No doubt, China has not given encouraging growth signals during our European holiday season. I am here not so much focusing on weaker official statistics (GDP, public investment, real growth in retail sales, etc.) but rather on analytically mostly unwatched or neglected signals.

But also hard statistical data were not really favorable – neither the PMI nor production indicators. The escalation of the trade war with the U.S. dampened business confidence, even if Chinese  trade numbers so far did not give particularly negative results (which according to experience and textbooks indeed could take some more time). But the Chinese currency yuan weakened visibly (not so much hidden this time but not very much related to growth concerns by the analysts); so did the two Chinese stock exchanges.

In this analysis, I do not focus very much on hard Chinese statistics. Major parts of Chinese are not (completely) reliable or have their quality shortcomings for other reasons. However, it is worth-while  paying increasing attention all the same when the Chinese themselves publish (slightly) weakening statistical numbers; such an indication came also in July from rising urban unemployment. In this also officially confirmed negative statistical sense growth could indeed be on its way to move in  a more dampened direction.

On the other hand, two developments outside the statistical sphere – which usually are not really observed by Western analysts in a more specific growth perspective – make me usually particularly curious in an economic growth context. They are

– (unexpected) loosening of monetary policy without interest rate cuts, and more than a very temporary weakening of the yuan.

Loosening of monetary conditions (by  decreasing cash requirements for the banks) has indeed taken place more recently despite the debt problem of local governments, firms and private households. It should be observed whether there is more to come in the nearer future.

The real reasons for the weakening of the currency yuan (also called the renminbi,  RMB) in 2018 may be in reality somewhat more opaque. First, there may be fundamental explanations for the drop of the yuan based on the existing  economic imbalances and also at least some negative impact from the trade war with president Trump, which means induced by market forces. Second, there may also have been Chinese political efforts to drive the currency down. My own guess is that reality may include both components. Perhaps the strong fall of the RMB was somewhat overdone but remarkable all the same.

Anyway, there is good reason to believe that Chinese GDP also officially will continue to slow down in the foreseeable future – but slightly and not very visibly apart from probably or possibly (net) exports. GDP growth around 6.5 percent for 2018 seems still be achievable in official real terms.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board

 

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