Is China heading for a hard landing?

Is China heading for a hard landing?

Good morning and welcome to today’s foreign exchange market commentary on Thursday, the 7th of February.

China’s economic growth in the fourth quarter of 2012 came in at a healthy 7.9 percent, half a percentage point higher than the 7.4 percent rise in the third quarter, and proving the pessimists wrong again. This also marked the nation’s second soft landing in a little less than four years.

China still relies heavily on exports and external demand despite all the talks about the coming shift to internal demand. The last slowdown had followed closely on the heels of a growth slump in two of its major export markets, the US and Europe. The latest soft landing followed in the aftermath of the European sovereign debt crisis, just as the earlier one occurred in 2009 after the US subprime crisis.

To be sure, China has several sources of stabilisers to withstand external shocks. Large foreign-exchange reserves, in excess of $3.3 trillion, and huge buffer of domestic saving (53 percent of GDP) tops the list. Also, unlike the West, China is yet to use up its countercyclical policy adjustments. Similarly, powerful urbanisation continues to support China’s high investment economy.

Nonetheless, this may well be China’s last soft landing where the country has managed to negotiate an external shock while keeping its growth intact. Many of the economy’s inherent strengths have been weakened by all too-frequent external shocks. The banking system is yet to recover from the impact of bad loans that followed the global meltdown in 2008. Corruption scandals and political risks have become all too pervasive while rising housing costs have become a serious problem.

In other words, the imbalances have gotten worse and the vulnerabilities have increased. Private consumption has fallen below 35 percent while the investment share of GDP is approaching 50 percent. The growth model has been stretched to the limit and the longer it stays there, the greater the possibility it will never return to its former resilient state.

The new leadership has its task cut out. Deteriorating credit quality of the banking system, rising wages eroding export competitiveness, key governance issues and last, but not the least, foreign-policy missteps – as witnessed in escalating tensions with Japan; all makes China vulnerable to shocks in a crisis-hit world. The country doesn’t have the luxury of time and its new leadership must act now.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.1572
GBP/US$ – 1.5658
GBP/CHF – 1.4256
GBP/CAN$ – 1.5605
GBP/AUS$ – 1.5172
GBP/ZAR – 13.9234
GBP/JPY – 146.36
GBP/HKD – 12.1315
GBP/NZD – 1.8706
GBP/SEK – 9.9490

EUR: The shared-currency eased against the US dollar as fresh news about the outlook for Europe sapped investor confidence. Markets grew concerned about a latest opinion poll that showed former Italian President Silvio Berlusconi’s political coalition gaining popularity. Berlusconi has proposed to reverse tax hikes implemented by present PM Mario Monti and markets are wary that the current reforms initiated by Monti will be reversed if Berlusconi wins popular mandate in this month’s general elections. The EUR/USD pair traded at 1.3522 compared to 1.3581 on Tuesday. Focus will also remain on the ECB’s policy meeting today in Frankfurt and any hawkish statement from the central bank will send the euro skywards again. Alternately, a negative statement could see the EUR/USD testing the next support level at 1.3425. The GBP/EUR is trading around 1.1665 now.

USD: The greenback broadly firmed up against its rivals yesterday, rising to the highest level in a week against the euro, but remained relatively flat against the pound. We have the BoE policy meeting due today though it is the testimony of incoming governor Mike Carney to the parliament’s Treasury Committee that investors would be more interested in. UK manufacturing data and trade balance figures are due today and any surprise gain will move sterling crosses. Mario Draghi’s press conference after today’s ECB policy meeting is what investors will be looking forward to and any toning down of comments is likely to boost sentiments. US unemployment claims data is also due in the afternoon and forecasts suggest a marginal improvement over last week’s reading. GBP/USD is trading around the 1.57 level now.

Have a great day!

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