Markets around the world are in a tailspin. The perfect storm of a U.S. interest rate hike, a Chinese slowdown and plummeting crude oil prices means the outlook for the world economy is dismal. If investor fears continue to grow, the global economy will sustain significant damage. The Nikkei Asian Review analyzes the impact of the turmoil on the economies of the region.
HONG KONG -- Global financial markets got off to a rocky start in 2016. Last year's U.S. interest rate increase, the first in nine years, was supposed to have finally overcome the trauma of the 2008 financial crisis. But by Jan. 21, when market jitters were high, the Dow Jones Industrial Average had lost 8.8% since the start of the year. Copper three-month futures, considered a leading indicator of the world economy, had fallen 5.8%.
The Chinese yuan symbolizes the market turmoil. The currency usually does not move much, but it has fallen 1.4% so far this year as of Jan. 21. Behind the drop is yuan being quickly pulled out of the country. According to the Institute of International Finance, the net capital outflow from China stood at $60 billion in April to June of 2015. The figure grew to $221 billion in July to September and to $239 billion in October to December.
Where has the money gone? The answer can be found in Manhattan. Close to the intersection of 53rd St. and Lexington Avenue, a 61-story condominium is under construction. The residential tower, whose penthouse will be sold for $65 million, is slated for completion in 2017.
What is interesting is the list of developers involved in the property. It includes state-owned nonperforming asset disposal company China Cinda Asset Management and China Vanke, a real estate company. Chinese businesses invest in property projects in the U.S. and sell them to affluent Chinese. This condo may be one such "all-China" property.
"We are seeing less individual investors with the smaller numbers of $1 million to $3 million. Now the larger purchases on an institutional level with north of $10 million have significantly increased," said New York-based real estate lawyer Edward Mermelstein. His remarks indicate how rapidly Chinese money is flowing into the U.S.
Investors are leaving Hong Kong, too. The Hong Kong dollar recently dipped to its lowest level in eight years and five months to 7.82 against the dollar. With share prices in Shanghai having nosedived 18.6% between the start of the year and Jan. 21, overseas investors are avoiding the Hong Kong stock market, where many mainland companies are listed. The Hong Kong dollar is pegged to the U.S. currency. Now market players are openly talking about a possible change in the exchange scheme. (See related story on Page 30.)
Investors' flight from the yuan reflects their concerns about the Chinese economy. China announced on Jan. 19 that its gross domestic product expanded 6.9% in 2015 in real terms -- the slowest pace in 25 years.
"The Chinese economy is having more difficulty than people generally thought a year ago," said Blackstone Group CEO Stephen Schwarzman. The steel and coal industries are being hit by a structural recession due to excess capacity and higher wages brought about by post-Lehman stimulus measures. Leaders in Beijing are aiming for a soft landing by transforming the economy into a consumption-driven one. But that is easier said than done.
Bubbles have burst in real estate and stock markets, preventing household assets from expanding. Wealthy Chinese are spending much less at home because of the government's anti-corruption campaign. Scaling down the industries hit by the structural recession could cause job losses and pour cold water on consumption. Global investors, including Schwarzman, are realizing China faces difficult policy choices. Investors, sensing danger, have shifted to a "risk-off" mode, sending Chinese shares and the currency even lower.
Businesses are taking protective measures. China SCE Property Holdings, based in Fujian Province, said on Jan. 6 it will redeem a $350 million bond before it is due in 2017. The company feared that if the yuan continued to weaken, the dollar-denominated debt would expand and badly damage its finances.
Chinese companies have increased their fund procurement in overseas markets to take advantage of lower interest rates, but this strategy has backfired due to the steep decline of the yuan. Shanghai-based Spring Airlines is among others mulling redeeming a bond before its maturity date. Chinese business leaders are becoming aware that foreign-denominated debts are a risk.
The situation in China is affecting the rest of the world, especially through commodities exports. China has been a major buyer of natural resources, and its economic slowdown has caused prices to tumble. Brazil, whose economy depends heavily on exports of iron ore and other resources, is highly likely to post negative economic growth for two straight years -- its first-ever multiyear contraction.
But China is not entirely to blame for the global market turmoil. The U.S. is also playing a part. Its rate hike last December is making the dollar more attractive to investors. Some of the $4 trillion that U.S. monetary authorities supplied to the world through quantitative easing after the Lehman debacle is returning. Crude oil prices, which have dropped by roughly 80% since their 2008 peaks, are another major factor.
Venezuela declared an "economic emergency" on Jan. 15. "We are confronting a true storm," President Nicolas Maduro warned Venezuela's parliament. The South American country garners more than 90% of its foreign currency revenue from crude exports. Russia is also feeling squeezed, as the oil-related sector accounts for roughly 40% of state revenue. Falling crude prices are dealing another blow to the country, which has already been spending much for "anti-terrorism" operations in Syria and military intervention in Ukraine. Russia is projected to post negative growth for two years in a row. Some market participants even expect a financial crisis there.
Non-oil producers are hurting as well. That is because oil producers are spending less money around the world to compensate for shrinking revenues. JPMorgan Chase forecasts that sovereign wealth funds, mainly from oil-producing countries, will sell stocks worth $75 billion this year to make up for falling revenues.
The U.S. is not immune, either. Wilbur Ross, known as the "Bankruptcy King" for his investments in failing companies, said, "25% of the shale people will go out of business this year. They cannot sustain themselves at these price levels."
Oil and gas producers are said to account for about 20% of high-yield corporate bond issuers in the U.S. If things go as Ross predicts, the recovering U.S. financial system and the economy would stagger.
Eye of the storm
A slump in the U.S. would certainly not leave Asian nations unscathed. But the Asian economy mainly relies on China, where the current turmoil began.
Standard & Poor's estimated the possible impact on Asia's economies if China's growth in 2016 were to be 2 percentage points lower than forecast.
Growth would be 2 percentage points lower than projected in Hong Kong and Singapore, 1.5 points lower in Malaysia, and 1.2 points lower in South Korea, the Philippines and Thailand. These countries would be hit by shrinking exports to China and falling commodities prices. A U.S. slowdown would make the situation even more grave.
The stock market is already reflecting this premonition. Since the start of the year, the tumble in the Chinese market has immediately spread to the rest of Asia, Europe and the U.S., which, in turn, caused Chinese and other Asian share prices to fall further. Since the beginning of 2016, the closing price in Shanghai has dived to a 13-month low, while Bangkok and New York have sunk to their lowest in 24 months and five months, respectively.
Many countries and market players are raising their alert levels. Bank of Thailand Gov. Veerathai Santiprabhob is one of them. "With this uneven recovery, we are increasing the list of data. We have a long list of information we have to watch," he said.
Bank of America Merrill Lynch conducts a monthly survey of fund managers around the world about the biggest "tail risk," an event that is highly unlikely to happen but would have a huge impact if it did. Forty-five percent of respondents named "a Chinese recession" in January, up from 34% in December.
The fund managers are seeing the unprecedented scenario of a global recession originating in China. Looking back on history, tail risks have periodically materialized. The oil crisis, the Asian financial crisis and the global financial crisis are some examples.
Neither the Chinese economy nor crude oil prices will recover anytime soon. That's why investors cannot shake off the fear of a tail risk wagging the global economy. Financial markets will continue to be volatile for some time.
Nikkei staff writers Momoe Ban in New York, Noriyuki Doi in Shanghai and Hiroshi Kotani in Bangkok contributed to this article.