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Chinese sneezes
Financial contagion from China now rivals that from America
Sep 24th 2016 | From the print edition
INVESTORS have long been wary of America’s sneezes, knowing they can give the world a cold. In Asia they now also fret about Chinese rhinitis, which is proving just as contagious. For financial epidemiologists, this is something of a puzzle. It is to be expected that germs can spread from China, Asia’s biggest economy, to others in the region. But it is surprising quite how infectious they are proving. Unlike America, enmeshed in global markets, China’s economy is in self-imposed quarantine, protected by capital controls that limit its interactions with others.
Yet China’s impact on Asian stockmarkets is now nearly as potent as America’s. Two recent papers, one from the IMF and one from the Bank for International Settlements (BIS), a forum for central banks, reveal the extent of the change over the past decade. The IMF estimates that the correlation between the Chinese stockmarket and those in other Asian countries has risen to more than 0.3 since June last year (1 is a “perfect” correlation), double the level before the global financial crisis. That is still below the 0.4 correlation between America and Asia, but the gap is closing fast (see chart). According to the BIS, Asian equities track swings in the Chinese market about 60% more closely since the crisis.
Investors already knew that China’s problems can ripple through Asian and, indeed, global markets. When Chinese shares crashed last summer and early this year, so did shares almost everywhere else. And when China let the yuan fall by 2% in August 2015, the currencies of other emerging markets tumbled. (The IMF found that the correlation between Asian currencies and the yuan is now more than 0.2, twice the pre-2008 level.)
Both reports cite the sheer heft of China’s economy as the main driver of the rising correlations. The data show that Asian countries with the strongest China trade ties are most affected by its market moves. Investors there are more likely to hold shares in companies that sell lots of widgets to China. They are understandably alarmed when stockmarket falls suggest that the Chinese economy is in trouble. And depreciation of the yuan, along with signalling economic weakness, makes it more expensive for those in China to buy things from abroad.
Trade, however, is not the only means of transmission. Financial linkages now account for about two-fifths of the correlations between China and other Asian markets, up from virtually nothing before 2008. Despite capital controls, China has opened channels that allow investors to buy its shares or lend to its companies. These foreign investments may be tiny relative to the size of China’s economy, but China’s wealth is now so great that they are still big in absolute terms. Foreign holdings of Chinese shares and bonds are worth about $2 trillion, more than for any other emerging market.
Asian investors have been particularly bold: claims on China and Hong Kong are worth more than 10% of GDP for South Korea, Taiwan and Singapore. As capital controls are relaxed, these financial connections will only deepen. For now, China’s bond market exists in a universe of its own. When the yuan becomes a funding currency for others, Chinese interest rates will affect those around Asia.
A tightening of correlations in Asia could, as the BIS notes, be welcome. In recent years markets across the globe have tended to move in the same direction, making it harder for investors to diversify. As cross-holdings proliferate in Asia, with China as a focal point, there is a real possibility that Asia’s financial cycles will find their own rhythm, pulling apart from other bits of the world. China and America will still suffer sneezing fits. With any luck, they will catch their colds at different times.
From the print edition: Finance and economics
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