The pro-cyclical Chinese economy

CHINA FINANCIAL - Report 26 May 2017 by Michael Pettis

Special points to highlight in this issue:
• Moody’s has downgraded China one notch from Aa3 to A1. Except for a brief flurry within the first half hour after the announcement, when markets reacted quite negatively to the news, the market response has been minimal.
• The main consequence of the downgrade will be whether or not it hinders Beijing’s efforts to encourage more foreigners to invest in Chinese bond markets. An increase in foreign capital inflows will reduce downward pressure on the PBoC’s foreign currency reserves and will give the central bank a little more room to manage domestic monetary policy.
• Foreign investment in Chinese bond markets, however, will introduce even more pro-cyclicality into the Chinese economy. Foreign investors are likely to come in when times are good and leave when times are bad, causing monetary expansion in the former case and contraction in the latter. Pro-cyclicality and debt are the two dominant characteristics of the Chinese economy.

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