If viewed on a standalone basis, recent developments in China strictly do not warrant the massive global stock market sell-off and financial dislocations that have followed.

Such a narrow assessment, however, ignores the cumulative impact of longer-term distortions that have taken root in the financial system, both inside and outside China. A major adjustment of policies is needed if these distortions are to be resolved in an orderly fashion. Otherwise, market forces could well force a reconciliation that will be a lot more disruptive to the financial system and the global economy.

China is in the midst of a structural economic transformation that is recasting its growth engines, away from external markets and towards greater reliance on internal demand. With that comes an almost inevitable slowdown in growth, compounding concerns about pockets of credit excess within the economy.