Chinese President Xi Jinping’s visit to Washington beginning Sept. 24 has been on the calendar since US President Obama’s invitation last year, and might have passed with limited fanfare were it not for the extraordinary currency and stock-market events of the past two months that also coincided with an economic growth and debt squeeze.
For China and general emerging market observers, the June Strategic and Economic Dialogue went largely unnoticed outside cybercrime-issue escalation and bilateral investment agreement consideration. Exchange rate undervaluation had been removed as a sticking point by US Treasury Department. IMF pronouncements that market forces were in play, and controversy over the new Asian Infrastructure Investment Bank, which Washington chose not to join, was partially defused by Beijing’s commitment to cooperate with Bretton Woods institutions.
However, the script for a cordial and quiet exchange of views has since been shelved. This is not only because of the threat of sanctions for China’s alleged computer network hacking, but also due to unprecedented post-2008 crisis doubts over banking and securities market health, Chinese GDP growth and the yuan’s direction that President Xi and his team must urgently clarify.
China’s leadership has already tried to preempt devaluation worry and reiterate its commitment to reform with official assurances. Premier Li recently said in a speech that no further weakening in the yuan was imminent. Top Chinese economic policy-makers also detailed their agenda for “mixed ownership” in the massive state-owned enterprise (SOE) sector at a recent retreat.
On the other hand, the Chinese currency has continued to decline in the offshore market toward 7 yuan to the dollar and Beijing has reportedly tried to intervene to reverse the trend. Additional formal depreciation before the Washington summit and through October’s IMF annual meeting in Peru would upset these events, especially as inclusion in the IMF’s SDR basket remains on the table. Nonetheless, global investor surveys now regularly cite Chinese currency risk in light of the record $600 billion in capital outflows during the past year that have depleted international reserves to $3.5 trillion. Recession, defined as growth in the 5% plus range, is another worry reflected in the latest industrial and consumer figures, and announced moves to introduce minority private ownership and fresh management at SOEs falls short of the competitive push needed to put the economy back on track.
Banking and shadow banking have been the subject of bland communiqués in the past. But recent troubles are raising their importance in the upcoming Xi-Obama meet. This mirrors how the 2008 subprime debacle was addressed in bilateral channels. The four giant state commercial banks continue to report earnings drops and non-performing loan increases, particularly in the real estate and local government sectors. The bad credit ratio is just over 1% according to local accounting standards. However, international estimates believe the damage could be halfway between there and the rate experienced after the 1990s regional financial crisis at 15-20%. Smaller private banks, bereft of sovereign backing, began experiencing liquidity difficulties last year when a crackdown began on high-yield informal trusts and the wealth management products they promoted. These structures have since been adapted in other forms and have the potential to wreak havoc. Underground and new online lenders that have previously escaped the net have come under regulatory scrutiny and are appealing to the government to rescue them.
Now that regulators have expended hundreds of billions of dollars in intervention and trading has been suspended in hundreds of listed Chinese companies, the Shanghai stock exchange is no longer accessible as a normal emerging market. US retail and institutional investors have dumped their holdings, but large sums remain trapped. Hedge funds like Chicago’s Citadel are under investigation for short-selling during the immediate crash. That practice has been banned during the 30% correction since June, which commenced just as index provider MSCI decided not to increase China’s core universe 25% weighting. With its actions and the absence of a timetable for lifting interference, both the mainland and Hong Kong will face calls for reductions and even suspensions from the benchmark gauge. President Xi may not have originally contemplated such a test ahead of his summit with Obama. But he will be measured in Washington for the first time globally by a strict and widely-followed financial system stability yardstick.
Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.
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