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China's slowdown is not a precursor to a recession and even less so a global one. Beyond the ups and downs in the short run, we believe that recent events in China form part of a long, tortuous process of structural change in the country's economic model which, by its very nature, entails a slowdown. We are still confident the Chinese authorities will achieve their aim while ensuring a soft landing for economic activity. Criticism due to their apparent inability to cut short the stock market crash, among others, is exaggerated because the harmful effects are modest (given the limited role played by the stock market in China's economy). However, critics seem to have underestimated the government's commitment to reforms aiming at amplifying the role played by free market forces, including the determination of the exchange rate, which helps to internationalise the yuan even further and gradually open up the country's capital account. Nonetheless, the Chinese economy still has grey areas, such as high leveraging in some business segments and local government as well as the state of bank balance sheets, suggesting that the weak tone (and mistrust) may continue for some time. The People's Bank of China (PBOC) cut its official rate in August and is very likely to do so again, as well as carrying out additional but controlled devaluations. This will exert downward pressure on inflation in the US and euro area, a slight effect but enough for the Fed and ECB to take it into consideration.
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