How Will China's Growth Affect the Markets?
China was recently recognised as the world's second biggest economy, officially overtaking Japan in GDP terms. But can it continue to grow? And what will be the impact on financial markets if it does?
Official figures released earlier this year put China’s GDP at $5.88 trillion, ahead of Japan for the first time (who's GDP stands at $5.47 trillion). China can also boast a very healthy growth rate of 10.3%, which has many commentators forecasting that the country could surpass the US in absolute terms in the next 10 to 20 years.
There is still a long way to go, however – US GDP is estimated at over $14 trillion. Also, analysts were making similar predictions about Japan 20 years ago, before economic stagnation set in. Japan was hit hard by the global financial crisis, and has only just returned to growth after declines of 1.2% in 2008 and 6.3% in 2009. Can China avoid going the same way?
Rising inflation
China's high inflation rate of 4.9% currently represents the biggest short-term barrier to growth. This is just the official figure, however, with some experts believing the real rate to be even higher. Inflation has been rising steadily since early 2010, and the Chinese Central Bank has increased the bank rate several times over this period in an attempt to bring it back into line.
If inflation continues to rise, there is the danger that China will become increasingly expensive in manufacturing terms as regards factories and businesses. This could result in an exodus to other, cheaper countries, which would hurt production and significantly damage the country's growth.
Large population
In the current conditions, investors in China will not be overly worried by this scenario. China's GDP growth rate stands at above 10%, and with a huge, increasingly affluent population driving domestic consumption, the Central Bank can continue its policy of hiking interest rates to bring inflation down to more manageable levels. If the government can solve the inflation problem and maintain the infrastructure needed for expansion, then a sustained period of growth is likely.
Market impact
If China can indeed continue to grow, we look at a few of the financial markets that could be affected the most.
Commodities
As investors have seen throughout 2010, growth in China generally drives commodity prices higher, due to an increase in construction projects and base metal requirements. A large population growing in wealth will also continue to fuel demand for soft commodities. Recently, the prices of wheat and cotton have soared due to significant demand in China and expectations that this demand could soon outstrip supply. Severe droughts in China and other agriculture-exporting nations have also put pressure on soft commodity supplies. In all likelihood, if China continues to grow, then commodity prices, both hard and soft, will continue to rise.
Stock Indices
As the US, UK and European markets struggle to create sustainable growth, it is clear that China has an important role to play in terms of the global recovery. In very broad terms, sustained growth in China should lead to greater global stability, greater risk appetite, and better conditions for equities as a result. All things being equal, stock markets should benefit. Digging a little deeper, the engineering and mining sectors look in good shape, with the former potentially set to benefit from large infrastructure projects (such as the expanding high-speed rail network) and the latter linked to commodity prices.
Forex
As ever, forex relies on a variety of permutations between the respective countries involved. Simply put, if China continues to expand and boost demand for commodities, this should lead to an improved outlook for the 'risk currencies' – in particular EUR, AUD, CAD and ZAR. Conversely, and again simply speaking, the relative safe havens of JPY and USD could suffer.
Chinese growth in context
As with all things concerning financial markets, it is imperative to understand that there are several factors involved here. Political concerns, such as the widening gap between the rich and poor in China, and the perceived undervaluing of the Yuan, are likely to play a major role in market movements. Similarly, China is just a single factor in a shifting economic landscape – global issues, such as the recent rises in oil prices, need to be carefully considered.
Take a position
Will Chinese growth help to advance commodity prices and boost stock indices? Or will the Dragon ultimately slow and perhaps allow the US dollar to advance? With IG Markets you can trade on global stock indices and commodities, as well as a variety of forex pairs, to back your judgement on Chinese issues. Opening an account online is easy; there are no forms to send and there is no obligation to fund.
Updated: 04/03/11
The above comments do not constitute investment advice and IG Markets accepts no responsibility for any use that may be made of them.
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