Entering 2016, the global economy is confronted with a number of risks. This has resulted in projections made by different economic institutions being at odds with each other.
Recently, the Financial Times collected the views and opinions of investors and strategists, and presented a selection of seven possible--though not probable--tail risks that the global economy may confront this year. Tail risk is defined as blows to investments that may occur, though are not necessarily likely to happen. Such risks include inflation in the United States, Europe's economic growth exceeding the U.S.', the UK's withdrawal from the European Union, etc.
Among these seven risks, the Chinese economy was the source of two, naming the prospect of a hard landing and a currency collapse. The message being sent is that it would be in the best interests of market investors throughout the world to keep a close eye on China's economic trends.
Why does the international market focus so much attention on China? A major reason can be attributed to a 3-percent depreciation of the yuan following the sudden reform of the yuan parity mechanism on August 11, 2015. That slump triggered drastic fluctuations within the global foreign exchange market as well as the commodities market.
It is clear to everyone that China's economy has a significant impact on the global market. China's economic growth is losing momentum and will face downward pressures this year. Moreover, the Chinese Government is carrying out new rounds of economic restructuring and reform. This is why some investors are hedging their bets due to mounting concerns and uncertainties.
However, those international investors' assumptions have deviated from the realities of the nation's economic issues. Admittedly, the current situation is difficult--but international investors seem to have ignored two fundamental factors regarding China's economy.
On one hand, market-oriented economic reforms are continually being carried out in an all-around manner, which has become an irresistible trend. After years of reform and opening up, China's economy has been characterized by regional disparity. Southeast coastal regions, for example, have reached the level of moderately developed countries. On the other hand, some central and western regions are less developed. It's such regional economic gaps that generate a buffer zone allowing China to mitigate and prevent problems from affecting the overall economic situation.
Take China's real estate market, for another example. Despite the fact that some housing bubbles had burst across some cities several years ago, the rest of the country hasn't been affected. Investors should take note, realizing that some of the risks that China's economy faces only have regional impacts.
Being populated by 1.3 billion people, China's market potential outstrips that of any other country in the world. Also, thanks to differences in regional economic development, the Chinese market is elastic as well as versatile. Products can therefore be tailored to a variety of consumer groups--creating a unique development environment for Chinese enterprises that allows them to adapt to different economic cycles.
Taking those factors into consideration, it's likely that China's economy has the capability to weather any difficulties it may encounter. In the past few years, some institutions and investors throughout the international market predicted China's economy would face insurmountable problems. However, all of those predictions fell flat due to fundamental misinterpretations of the general market conditions at that time.
The other so-called risk is the steep fall of the yuan's exchange rate in 2016, as some investors have predicted. In the eyes of some international investors, a declining yuan exchange rate would cause a serious outflow of capital and send a negative signal concerning China's real economy. Should China's foreign exchange reserves dwindle rapidly, domestic assets' price bubbles will burst. That would purportedly result in the international market becoming skeptical of the effectiveness of the country's monetary and foreign exchange policies. In that case, the global economy would hit a wall.
The fluctuation of the yuan exchange rate is a potential risk. However, China's central bank is not likely to fix the yuan exchange rate once more. Instead, it is striving to ensure that the yuan floats in a free and flexible manner. At the same time, Chinese regulators are capable of properly controlling the exchange rate while simultaneously enhancing the elasticity of the yuan.
In a nutshell, when tackling issues involving the yuan's exchange rate, China will be able to play them by ear while analyzing the trend of the yuan's exchange rate in 2016.
Looking back at 2015, the China-led Asian Infrastructure Investment Bank (AIIB) and the New Development Bank of BRICS were established, and the yuan was included in the IMF's Special Drawing Rights basket, signifying China's growing influence. Looking forward to 2016, as the AIIB issues its first loans and China hosts the 2016 G20 summit, the country will contribute more to the improvement of the global governance system and its economic growth. In that sense, China will remain the engine of the global economy, rather than a source of risks.
This is an edited excerpt of an article written by Yi Xianrong, a professor at the School of Economics of Qingdao University, and published in National Business Daily
Copyedited by Bryan Michael Galvan
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