• Says China needs a more robust exchange rate, better reforms
  • Chinese stocks extended their slide Monday, dropping 5.3%

China’s market ructions are likely masking a credit crisis and a bleak outlook for its economy, according to UBS economic adviser George Magnus.

"Beneath all of the financial turbulence there lurks, in my view, a credit crisis," Magnus told Tom Keene and Francine Lacqua on Bloomberg Television on Monday. "I fear the worst now."

The worries about the Asian economy triggered a stock-market rout that rippled around the world and pushed the offshore yuan to a five-year low last week. While China’s top policy makers promised a wave of reforms in December, including promoting flexible monetary policy and boosting agricultural production, they aren’t likely to be enough, Magnus said.

“Incremental reforms do not substitute for the changes to the way in which your institutions function and the way in which your economy can respond to those institutional changes,” Magnus said. “The reform agenda, in many ways that really matters, has stalled" and so "things are looking much bleaker for China going forward."

Not Containable

Magnus has a track record for calling the outcome of global upheavals. In July 2007, Magnus warned that the U.S. subprime mortgage-market collapse may not be “containable.” In September 2008, he called for the U.S. Federal Reserve, the European Central Bank and the Bank of England to cut interest rates to prevent the financial crisis from worsening, a step they took two weeks later.

"One of the issues that financial markets are grappling with is, what is the foreign-exchange strategy?" Magnus said. "There’s a very plausible case to say that actually what China really needs is a more robust exchange rate” and to make needed adjustments on the domestic economy, cut taxes for households, transfer wealth from the state sector to the private sector, and cut overcapacity.

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