Prashant and RashananadBy Prashanta Chandra Panda & Rasananda Panda*

It will be another interesting phase of world economic growth where developed economies continue to have low Gross Domestic Product [GDP] growth, low inflation with plentiful of money. Expansionary monetary policy undertaken by major economies like US, a long run continuance of low interest rate regime also in Europe , Japan as a weapon to hold growth steady, is gradually showing its withdrawal syndromes.

However a trend of good growth in the recent past and an experience of riding risks smoothly have in fact made Financial Institutions to think positively on alternatives to create and gain more out of short term volatile price movement. This they can attempt more by convincing themselves about the robustness of the system to fight deflationary phase with a directed movement of easy liquidity.

With synchronization in expectations they will be in a position to ride another round of risk with a gain. The current struggle to have convincing growth in emerging markets especially China, Russia, South Africa, Brazil and India, slow growth in Europe and Japan is definite to make capital relatively abundant.

This scenario of low world investment coupled with low inflation is definite to release more money to create and ride waves in opportune time. There may be higher velocity and volatility in stock markets in many of these economies with some irregular short time frequency (expected).

Significant concentration of financial power with a few institutions, PEs, HNIs makes it possibility to look for ways to have higher yields by aligning their risks in one way at one time. Lack of real investment opportunities may force these significant players to initiate actions under a win-win scenario under market pessimism over real economy performance. It is easier to convince this movement of capital as it is used to better returns in recent trends. We mean to say that Foreign Institutional Investors will have major sway in the swings in equity markets in these markets.

dragonThe domestic investors (if alert) may gradually book their ways to higher hold with big buying positions when the market corrects for positive territory. Retail investors’ interests will dwindle after a few rounds. FIIs of low interest rates and stable currency regime origin will be the biggest beneficiaries even if the savings rate in these economies may be low.

The world was really shocked in the month of August, 2015. The Shanghai Composite Index fell 39% from peak (of June 12, 2015) in a matter of one month and fifteen days. The investors suffered a market capitalization loss/ value loss to the tune of $5 trillion as traders were forced to cut their leveraged bets.

It is difficult to bet for reasons by rationalists as to why it appeared as a shock to the market when world is waking up to the realization of devaluation of Chinese Reminibi (RMB). Moreover this has been in the desired line of IMF thought. IMF is already thinking of how to place weightage of Chinese currency presence in the valuation of SDR. SDR’s currency basket is loaded with combined weightage of 41.9 % US $ and 48.7 % European € and £.

Though the Asia has been major centre/ hub for trade and development in the last decade, the currency weightage of ¥ has been 9.4 % with no weightage for Chinese Yuan or South Korean Won. Is it because that they have low presence in transaction market or low in international transaction. The market share of Yuan usage in trade finance, or Letters of Credit and Collection, was 8.66% in October 2013. Now this has reduced 5 % with most strength accumulated from Asian partners in trade with China.

Society for Worldwide Interbank Financial Telecommunications, or Swift data shows a rise in the Yuan’s use in global payments, trade settlement and money-market instruments. By setting up currency-swap pacts with countries in emerging and developed markets, opening up parts of its capital market to outsiders Yuan tries to consolidate as a dependable international currency.

So, a part of fall can be taken care of by these developments. The devaluation also adds to the charm of Yuan settling as negotiable instrument in trade settlement at least for China’s trade partner countries in Asia with other nations as it boosts their exports (due to this devaluation to begin with). In a way indications were strong for Yuan holding its positions rather than facing the onslaught of capital flight from domestic market. For all these reasons it is difficult to understand the greeting of RMB devaluation with a massive capital flight out of China. Even India faced similar fate.

It may be that market thoughts that bet on China succumbing to US line of pressure of RMB revaluation in the event of continued Chinese surplus in exports. Is it simply an outcome of new found mystery that world loves to discuss, trade and current account surplus is no longer a stronger reason for continuance of revaluations of RMB in phases to inch closer to market determined external value of Chinese Yuan. Still capital flight out of RMB home market is bit difficult reason out.

Yes, it seems Chinese export led growth supremacy is not as strong as Chinese mystery over the way home market is regulated, supported and promoted. China growth continues contributing to the demands of the competitive world economy. China enjoyed getting resources at competitively less rate being a destination of investment for her efficiency in production and for bigger domestic market for products.

It is excessive mix of State interventions in the interests of the markets for which China grew at the expense of graphtrading partners. The State has been supporting the economy directing its resources to its contributing industries. They get capital cheaper from these controlled organizations with over-all pro-investment climate policy at home.

This in addition to huge flow of FDI and FII must be heading cost-push inflationary symptoms northward due to the pressure of prolonged growth. State interventions added to competitiveness in financing of projects as well as avoiding overheating in real economy. Stiff competition due to relative gain in strength of dollar against trade rivals of China, pressure on exports may have made China to succumb to the charm of devaluation just to steady the ship.

Nothing mattered as long as investors’ money was growing. The moment growth slows down market transparency is first to be questioned and is left open for market scrutiny. These small fears against export drops have doubled as the World make a re-assessment of Chinese financial system as growth reduces to 6.5% against Chinese determination in reforming the capital market.

Speculators or even astute FIIs must have thought of redesigning their moving out and moving in cycle at an early date to book their bigger gain and others to book their gains or minimize losses in case of late entrants. Now leading currencies behave differently. In the last one year Rupee has fallen against dollar by 6.5 %, appreciated 11 % by British £, and 14% against €.

So such moves appear rational at a point. A systemic risk could have been avoided if FIIs acted in the expected lines of Chinese think tanks. Perhaps the anticipations appear more on inevitable smart exit strategy of the money dumped in China via different routes from the Quantitaive Easing Programmes by the US government.

And a combination of mixed reactions to much inevitable transit to an economy based on domestic demand for which China’s focus may change and anticipated tightening of interest rate in US. So, there may be bigger fear for money locked in assets via M & A in China as scenario is confusing as policy focus is yet to be assessed.

The time gap in this redesign of wealth/ asset ownership between State directed capital infusion and spread of ownership net with more institutions and individuals is opportune moment for early birds to move out to enter at a subsequent lower market capitalization.

In-fact the government design is in line of creating market capitalization in a linear way as the valuations are backed up with volumes in many cases. The release of government holdings in such assets would have allowed big help for China for much needed acquisition foreign natural resources and even companies courtesy sovereign fund. And the initial setbacks of financial market reforms could have been taken care of.

A positive response of FII or even a wait and watch policy could have helped more institutional and domestic players to take part in buying to add to the strength and resilience of capital market of China as has been design of Chinese president XI. A systemic risk could have been avoided if FIIs acted in the expected lines of Chinese think tanks.

Perhaps the anticipations appear more on inevitable smart exit strategy of the money dumped in China via different routes from the Quantitaive Easing Programmes by the US government. And a combination of mixed reactions to much inevitable transit to an economy based on domestic demand for which China’s focus may change and anticipated tightening of interest rate in US. So, there may be bigger fear for money locked in assets via M & A in China as scenario is confusing as policy focus is yet to be assessed.

(To be continued)

[Prashanta Chandra Panda is currently Professor of Economics, KIIT University, Bhubaneswar and Rasananda Panda is Professor of Economics, Mudra Institute of Communications, Ahmedabad]