The fallout from China’s devaluation and market sell off continued to dominate much of the country risk world this month. On August 11, China’s central bank intervened in the currency market, prompting a 3% drop in the value of the yuan against the greenback. Less-than-impressive data on China’s exports and the currency’s peg to the US dollar (which had appreciated just under 20% on a trade weighted basis over the last year) were the most obvious catalysts to the bank’s move. But the country has also been dealing with structural issues (e.g., rising labor costs) over the past decade, and the yuan’s spot price was trading at slightly less than the fix. As such, the devaluation was not entirely unexpected, and there is much speculation now that a further weakening of the yuan (to about 10%) is in the cards.
While the global markets were adjusting to the new currency regime, concerns about the future growth of China (some not-so-nice manufacturing data came in) touched off a broader global market sale in a wide range of assets. Chinese shares continued to plummet, inducing the central bank to act once again, this time by lowering the benchmark one-year lending rate 25 basis points to 4.6%. The bank also announced a cut to the one-year savings rate by 25 basis points to 1.75%, adding that it would lower the reserve requirement ratio for large banks 50 basis points to 18% as of September 6th. Despite this, Chinese share prices continued to fall, and investors sold their holdings in US treasuries and other so-called “safe haven” assets. Yet many emerging market currencies got a lift, as did much of the beaten-up commodity market.
Looking forward, the swoon in China’s stock market, while significant, does little to shed light on some real issues affecting the economy including excessive debt, a shadow banking system, and a political apparatus that appears to be coming under increasing pressure for its lack of transparency and ability to get traction from its policy responses. A case in point on the latter is the recent chemical explosion in Tiajin, which claimed the lives of hundreds of people, and in which the handling of the crisis by the authorities has been characterized as less-than-transparent and generally inadequate, particularly in light of a world now dominated by social media and quick data transmission. Indeed, as it affects the financial woes afflicting the nation, the speculative bubble associated with the stock market may be beyond Beijing’s control to manage. And if that proves to be the case and there is a market panic or severe economic downturn that undermines the country’s sense of financial well-being, then the public may be motivated to mobilize for deep political change.
Leaving China aside, Greece has also received a third bailout package from the eurozone to the tune of some $95 billion. The money attached to the deal gives Athens some breathing room vis-à-vis its creditors, but given the tough austerity measures it imposes on the country it seems rather unlikely much of it will be executed by the authorities. Complicating matters, Prime Minister Alexis Tsipras resigned from his post, and called a snap election as lawmakers within his Syriza party rebelled over the terms of the deal. Some 25 members broke away to form a new left-wing party, Popular Unity, explicitly opposed to the bailout.
Following the resignation, Greece’s president, Prokopis Pavlopoulos, assigned to two opposition parties the task of forming a new government in an effort to avoid the vote. Nothing has really come of this and an election is expected to be held on September 27. We still think Syriza will emerge from the vote as the largest party in the legislature but without a majority, which will force Tsipras to find a coalition partner. If coalition talks failed, the president will have to call on the second- and third-biggest parties to form a government. If this move fails to produce a government, fresh elections would have to be held.