The recent stock market volatility in China highlights the challenge the country’s authorities are facing from implementing market reforms without disrupting stability, says New York-based Moody’s Investors Service in a new report published on Friday.
This latest episode of stock market turmoil in China “suggests that the Chinese authorities are finding it increasingly difficult to reconcile the tensions inherent in designing and implementing credible and effective reform measures while maintaining economic, financial and social stability,” the report from the credit rating agency ays.
In the short term, Chinese authorities will prioritize meeting their economic growth targets, the Moody’s report says. It is projecting that Chinese GDP growth will slow to 6.3% in 2016, after coming in at just under 7% in 2015.
“A further marked slowdown in commodity, construction and heavy industry sectors will be offset by significant fiscal and monetary stimulus,” the Moody’s report says. “However, further financial market volatility is likely as the method and pace of implementation of reforms and possible counter-measures remain uncertain.”
That uncertainty has been highlighted this week as stock market circuit breakers were installed on January 4 in China. However, after the circuit breaker twice lead to trading halts this week, Chinese authorities have now abandoned them.
China could try to stoke growth by devaluing its currency, the Moody’s report suggests, but it warns that this could have negative implications for both China and the rest of the world too. “For China, a weaker currency risks fuelling further capital outflows and reducing foreign exchange reserves,” the report says. Whereas, for other countries, a significant depreciation “would exacerbate existing deflationary pressures.”
“As in the case of the equity market, the authorities’ willingness to adopt measures with potentially large negative consequences illustrates the difficulties they face in transparent and smooth reform implementation,” the Moody’s report says.
These challenges are, in turn, impeding the recent efforts of Chinese authorities to give market forces a greater role in the economy. “The short-term negative consequences of these reforms in dampening economic growth and exacerbating volatility in the financial markets have dominated in recent months, triggering responses by the authorities that have slowed or even reversed the reforms,” the Moody’s report says. “As a result, the credibility of the authorities achieving a smooth implementation of China’s economic rebalancing is being dented, and this is a credit negative.”
A separate report from New York-based Fitch Ratings notes that these efforts at shifting to a freer market economy are also undermined by the Chinese government’s use of the country’s banks to support state policies. Authorities “frequently use the banks to address systemic risks,” the Fitch report says.
China’s practice of bailing out heavily indebted companies through banks will delay the country’s effort to develop a more market-driven financial system, the Fitch report says. “This means China will remain a centrally controlled economy despite financial reforms and effort at rebalancing the economy that had implied a greater role for market forces,” the report concludes.