China's attempt to slow down a headwind for global economy

It is often said that when China sneezes, the world catches a cold.

The World Bank recently raised its global GDP growth estimate for 2014 to 3.2 percent from its earlier estimate of 3 percent back in June 2013. This is the first time in the last three years that the forecast for global growth has been raised as the developed nations inch towards pre-crisis growth rates.

Kaushik Basu, the bank's chief economist, wrote in the report: "For the first time in five years, there are indications that a self-sustaining recovery has begun among high-income countries."

Even though the overall consensus is bullish for global equity markets, most asset managers point out a faster than expected slowdown of the Chinese economy as a major headwind to their upbeat view.

At this juncture, it must be understood that Chinese policymakers and officials at the People's Bank of China (PBOC) would rather have a consolidating Chinese economy than an 8-10 percent growing economy which has led to unsustainable debt levels and a surge in inflationary pressures due to a lending spree. China realizes the long-term risks posed by an overheated economy and Beijing has put measures in place to burst bubbles building up in the credit and housing markets.

Recent price action, especially the falling commodity and energy prices, implies  the market pricing in a moderate growth rate in China, well below its previous ten-year average of around 9-10 percent. The sharp decline in the Australian dollar, a commodity currency, whose fortune depends on the physical demand for commodities from China, also confirms this fact.

Data released on Wednesday showed that the pace of lending slowed in the second half of 2013. This was reflected in the total social refinancing numbers which is the Chinese government's favourite measure of credit creation.

According to the Wall Street Journal, the new financing issued in the fourth quarter of 2013 was down 17.9 percent from a year earlier. This was on the back of huge credit growth in the first half of 2013. However, overall new credit rose 9.7 percent to 17.29 trillion Yuan year on year in 2013,  showing that efforts of the PBOC to curb excessive credit within the financial system are likely to continue.

Lending by shadow banking institutions, such as trust companies, securities firms and insurance companies, rose by 43 percent to 5.16 trillion Yuan compared with 2012 according to the Wall Street Journal. Inter-bank rates reached almost 30 percent last year leading to cash shortages in the inter-bank market on three separate occasions last year.

Yet, the level of debt remains at levels which leaves China's financial system vulnerable. Thus, we can expect these credit tightening measures to run into the foreseeable future which would no doubt imply slower GDP growth in the coming quarters.

This consolidation phase should also be used by the upper echelons in Beijing to fundamentally restructure its economy towards a more consumption driven one than being one so heavily dependent on investment demand. Gradually, China will also have to allow the yuan to appreciate against the US dollar and other major currencies to get rid of the 'currency manipulator' tag - which would hurt its massive export and cheap manufacturing hub.

Over the next couple of years, the above factors would bring with them some short-term pain which is a natural outcome following such re-adjustments. But if China is to truly cement its place as a well balanced and sustainable economic superpower, such steps must be implemented now.