A new assessment from Goldman Sachs finds deep problems in China’s economy. Bloomberg:
There’s a growing risk that capital outflows from China may accelerate as the yuan weakens, spilling over into global markets and causing a broad selloff similar to those in January and August, according to Goldman Sachs Group Inc.
“We shift to an outright negative view” on the yuan, strategists led by Robin Brooks wrote in a note Thursday. As the People’s Bank of China guides the yuan lower against the dollar, “the risk is that this re-ignites capital flight in the same manner it did in August (during the mini-devaluation) and around the turn of the year,” they said.
The yuan is poised for the fifth weekly decline, the longest losing streak since December, amid mounting expectations the Federal Reserve will raise interest rates this quarter. In January, Chinese currency weakness triggered a global equity selloff amid concern the government may engineer the second devaluation since August to bolster growth. By March, the Fed cut its forecast for its long-term borrowing costs, citing uncertainties in China.
While experts give detailed assessments of a “growing risk” of a 2015 repeat, many investors on the ground have already made up their minds and are sending ever-larger amounts of money overseas. Beijing has been struggling to stop capital flight for the past year. But every effort to limit outflows has been met by even more creative workarounds. Capital flight only further weakens the yuan, and so it could trap China in a cycle of outflows and continued devaluations.
In the first quarter of this year, there were some signs of life in the Chinese economy even as capital fled, but now, there are very few. May’s numbers show manufacturing taking a turn for the worse amidst overcapacity, automation, and offshoring. More concerning, however, is the slowdown in the services sector, now the biggest piece of the economic pie. The strength of the services sector had been considered evidence of a critical economic transition to a new consumer-based economy. If that transition isn’t happening, China’s problems may be more serious than had been appreciated.
China’s economy still has a lot going for it in the long run, but in the immediate term, things look rough. A Federal Reserve interest rate hike is reportedly on the horizon (although poor U.S. jobs numbers may delay it), and if it comes soon, it would coincide with a cyclical mid-year lull in mainland credit availability. Hong Kong’s financial sector is already finding itself in its worst shape since 2008. The bite of a capital crunch on an economy that has long benefited from large private investments will cause even more hurt and give remaining investors even more reason to get out. With rumors of a political feud between President Xi Jinping and Prime Minister Li Keqiang giving further grist to the idea that political calculations rather than economic calculations are driving reforms, there’s a real risk that the volatile yuan will jerk China and its leadership around with it.