Deadly assault brings new kind of risk to China

March 3, 2014

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The shocking knife attack that left at least 33 dead in Kunming railway station brings a new kind of risk to China. Investors’ belief in the relative stability of the People’s Republic has allowed it to weather political purges and border disputes without upsetting asset prices or capital flows. But rising ethnic tension could lead to a damaging recalculation at a fragile time.

Political risk is a big driver of a country’s cost of capital. In China it has been low, at least over the time frame most investors care about. They remained calm during the purge of Chongqing party chief Bo Xilai, recent attacks on police stations in western Xinjiang and even an apparent suicide attack in Beijing’s Tiananmen Square. In all cases, the authorities appeared more or less in control. Compared with troubled democracies like Venezuela, Ukraine and Thailand, China’s one-party rule has been seen as an asset rather than a liability.

The latest assault, which China’s state media blamed swiftly on Xinjiang militants, looks different. The timing is important: China’s annual parliament is about to meet in Beijing. Meanwhile, the fact that it happened not in northwestern Xinjiang but in southwestern Yunnan, and targeted civilians, points to a rising risk of random violence across the country.

This may prompt domestic and international investors to reassess the risks they associate with China. Only a small increase in the cost of capital could translate into a big fall in financial markets. China’s currency, the yuan, has been sliding for two weeks. But what seemingly started as a deliberate attempt by the authorities to deter speculators could turn into capital flight if investors now decide yuan-denominated assets are more risky and volatile.

The state’s ability to crack down remains powerful, and assailants’ use of knives suggests their methods, while gruesome, are not sophisticated. But unrest in the financial world may be harder to control. Thin liquidity cushions and reliance on “shadow bank” lending make China’s financial system vulnerable to short term changes in fund flows, while even a slight recalibration of China’s risk premium will reverberate across world markets. It’s not just political stability that is being reassessed.

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