Scared of a China hard landing? You should be
Summary
China’s economy has slowed steadily since 2010, when gross domestic product (GDP) growth last topped 10 percent. China’s President Xi Jinping is predicting 6.5 percent GDP growth next year and the International Monetary Fund is forecasting 6.3 percent.
It’s the market doom-and-gloom scenario: A “hard landing” for the world’s second-largest economy.
China’s economy has slowed steadily since 2010, when gross domestic product (GDP) growth last topped 10 percent. China’s President Xi Jinping is predicting 6.5 percent GDP growth next year and the International Monetary Fund is forecasting 6.3 percent.
However, Oxford Economics, an advisory firm, has put the world through a stress test to show what would happen if Chinese growth slowed to 2.4 percent in 2016 and only recovered to 5 percent after five years.
The scenario might seem extreme, but Societe Generale warned in October that there was a 30 percent risk of a China hard landing. In the French bank’s model, this would see Chinese GDP fall to 3 percent in 2016.
Oxford Economics warns that the risks to Chinese growth were “substantial” and “would have a profound effect on the global economy.”
Here is a look at some of frightening implications of a China hard landing.
Russia worst-affected in hit to world GDP
The weakness in China would spill over to countries across the globe, with world growth seen by Oxford Economics slowing to 1.7 percent, compared with its baseline forecast of 3.0 percent. Global growth would disappoint again in 2017.
“A China hard landing would have a profound effect on the global economy. It would weigh heavily on emerging markets. And advanced economies would not be immune,” Oxford Economics said in its report.
Emerging markets and commodity-producing nations would bear the brunt, as China is a major consumer of energy and other commodities. Russia was seen worst affected by Oxford Economics, with its economy forecast to grow by nearly 5 percent less in 2016-17 in the event of a China shock.
More developed countries closer to China would also suffer a big shock, with growth in Hong Kong, Singapore and South Korea seen coming in 3 percent-plus lower in 2016-17 than the base line.
US, UK, French and German GDP growth would also be hit, albeit by less than 1 percent, according to Oxford Economics.
“The most likely trigger for a China hard landing is policy error, with a miscalculation of how much financial risk management or structural reform the system can absorb,” Societe Generale economists and strategists, led by Patrick Legland, said in a multi-asset report in October.
“The currency regime change is a case in point. If not managed properly, capital outflows and external debt risk could inflict severe pain on the financial system.”
USD 35 oil
A hard landing in China would weigh on demand for energy and other commodities. While this would benefit some net importers, including several major European economies, like the U.K. and Germany, as well as the US, it would weigh on others. That includes Russia, oil-exporting Gulf countries like Saudi Arabia and Chile, where commodities account for more than 50 percent of its export earnings, according to Oxford Economics.
Crude oil prices have already slumped by more than 55 percent since June 2014, as waning consumption by China has exacerbated a supply-demand imbalance.
As a result of the China hard landing, oil prices fall toward USD 36 in the Oxford Economics scenario or USD 35 in Societe Generale’s one. The bank said Brent crude could remain at USD 35 a barrel for the first half of 2016, creeping back above USD 40 by 2017.
Some of the countries that are most reliant on commodity production are also the most dependent on trade with China, leaving them doubly exposed to a hard landing, said Oxford Economics.
Even developed nations are vulnerable, with Australia, a net energy exporter, selling over 20 percent of its value-added exports to China.
A shift away from investment-intensive growth could also expose countries that export capital goods to China. These include countries like Germany, where capital goods account for almost two-thirds of China-bound exports, according to Oxford Economics.
S&P 500 tumbles
Societe Generale warned that a China hard landing could knock as much as 60 percent off the US S&P 500. This would take the benchmark stock index back to the lows of 2009 that followed the global financial crisis.
“We think that after such a shock the global equity market would rebound strongly on a return to growth in China and central banks’ actions,” Legland and colleagues said in October’s report.
Halt to Fed hikes
The US Federal Reserve is seen starting to hike interest rates when it meets this month, but a China hard landing would put the tightening cycle on hold, said Oxford Economics. The Bank of England would also delay raising rates and the European Central Bank would hold the rate on its main refinancing operations, which provide the bulk of liquidity to euro zone banks.
“The policy response that greets a major shock to Chinese activity could be more profound than assumed in our simulations. In China, the authorities might seek to counterbalance the slowdown more actively through expansionary fiscal measures and encouraging greater bank lending. More generally, with so many countries bound by constraints on conventional monetary policy at the zero lower bound, additional unconventional measures could be countenanced by various central banks across the world,” Oxford Economics said.
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