Devaluation hints at China’s rising distress over its economy

Whenever China’s economy swooned in recent downturns, its currency never buckled. It held steady, or strengthened, even as China’s neighbors or trading partners scrambled to cut the value of their own currencies to deal with the fallout.

With the Chinese renminbi now taking its biggest plunge in decades, the worry is that the country’s already slowing economy is even worse off and the government is panicking.

By the official measures, the economy is growing at 7 percent, right in line with government targets. It is a steady pace that the leadership has indicated can support decent job growth and put more money into consumers’ pockets.

But a look below the surface shows a different, more worrisome picture.

Core parts of the economy, including construction, are weaker than ever as the real estate industry struggles. Consumer spending, which was supposed to pick up the slack, is not that strong. And financial services, a big driver of economic growth when the stock market was booming, are slipping.

The numbers coming out of China, too, are somewhat suspect. Economists now wonder whether, despite official figures showing growth, some provinces and regions could be dealing with outright recessions.

“To be honest, no one has a clue where the economy is, and I don’t think that it’s properly measured,” said Viktor Szabo, a senior investment manager at Aberdeen Asset Management. “Definitely there is a slowdown. You can have an argument about what level it is, but it’s not 7 percent.”

The government’s aggressive action on the currency has brought the economy into sharp focus.

China allowed the renminbi to weaken even further Wednesday after a sharp devaluation the previous day. The currency’s official fixing against the dollar is down 3.5 percent in the last two days. On a typical day, the renminbi rises or falls just a small fraction of a percentage point.

The weakening of China’s currency sent U.S. markets sharply lower at first Wednesday, but indexes recovered nearly all the ground they lost by the end of the day.

While the government said the currency decision was intended to make the currency more in line with markets, the devaluation was also largely a gift to exporters. In relative terms, it makes China’s shipments of clothing or electronics to consumers in the United States or Europe more affordable.

“I don’t see this mini-devaluation as some kind of outrageous act,” said George Magnus, an economic adviser to the bank UBS and an associate at Oxford University’s China center. “But it is part of an array of other economic and financial stimulus measures designed to shore up the flagging growth rate.”

The government has taken the usual steps by cutting interest rates and freeing up more money for banks to lend. But the leadership has also turned to more unconventional means in recent months to try to cushion the blow as the economy’s once runaway expansion sinks back to earth.

It relaxed a rule that banned investment companies tied to local governments from piling on debt. When the stock market slumped, it aggressively moved to halt the slide. It has also pledged tens of billions of dollars in support to state-controlled policy banks for loans to favored projects.

China’s plan has been to wean itself off a debt-driven growth model that has led to wasteful, government-led investment. Instead, policymakers want consumers to become the main engine for the economy, but that will take time.

They hoped to maintain growth by keeping credit flowing to favored projects, a nationwide program that amounts to trillions of renminbi worth of investment in new infrastructure. The money is going to redevelop shantytowns, expand road and rail networks, and build wastewater treatment facilities.

In the city of Liupanshui in Guizhou, one of China’s least affluent provinces, the local government is building its first subway line. Local officials hope to bring in private investment to help finance the line, at a budget of $1.6 billion.

But such efforts have not been enough.

Infrastructure investment is rising, but it has failed to offset the nationwide pullback in spending on new factories and apartment block towers. In July, overall investment in fixed assets rose 11.2 percent, the slowest increase in 15 years.

Consumers aren’t yet able to shoulder the burden of driving the economy. While incomes are still rising, the job market has started to show signs of stress. Vacancies are declining across the market as companies reduce hiring in response to slowing business growth.

The stock market slump has also taken a toll, with the main Shanghai index down about a quarter from its peak two months ago. Ordinary investors have poured money into the markets during the last year, and many are now sitting on losses.

The overall result is that consumers are spending less.

This story was originally published August 12, 2015 at 4:59 PM with the headline "Devaluation hints at China’s rising distress over its economy."