China’s attempt to balance its economy, without breaking it, puts global growth at risk should policy-makers fail.
Premier Li Keqiang’s three-month-old government is allowing the tightest squeeze on credit in at least a decade, to wean the nation off a cash binge that threatened to destabilize the world’s second-largest economy.
The aim is to deliver sustainable, more-even economic expansion closer to 7 percent than the rates faster than 9 percent witnessed in recent years. The risk is that getting the transition wrong will stifle credit and hurt activity at home and abroad just as the Federal Reserve pivots toward withdrawing stimulus.
“I wasn’t too worried up until this week,” said Shane Oliver, Sydney-based head of investment strategy at AMP Capital Investors Ltd, which manages the equivalent of more than $119 billion. “Things are quite a lot different in China than might have been expected. It does potentially pose risks for global growth.”
Oliver is among investors and economists from Barclays Plc to HSBC Holdings Plc who are lowering their outlook for the Chinese economy. They say it may fall short of the government’s full-year growth target of 7.5 percent.
That’s a challenge to countries from Australia to Brazil that increasingly relied on China after developed nations struggled to recover from the worst international recession since World War II. China was responsible for about a third of global growth last year, according to Darius Kowalczyk, a strategist at Credit Agricole CIB in Hong Kong.
“The world economy would suffer from China’s slowdown, as China has been adding more to global growth than any other economy,” said Kowalczyk. “Commodity demand would suffer in particular, and Asian markets relying on China for exports growth would be hit.”
Concerns about Chinese officials getting it wrong threaten to roil global financial markets, said David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York.
“If people get scared about China, that could be a global event that would weigh on sentiment and reinforce negative forces in the markets,” said Hensley.
The danger of over-doing the pullback is magnified by the fact it comes as investors contend with the prospect of reduced stimulus from the Fed. Emerging-market stocks are headed toward their steepest weekly loss in 13 months, with the MSCI Emerging Markets Index sinking to 899.78 as of 11:13 a.m. in New York. The Chicago Board Options Exchange Volatility Index, the so- called VIX, surged to its highest since December yesterday.
“We’ve relied on the Fed and China so much over the last few years, so any signs that either might be less supportive is taken negatively—and we got both of those over the past week,” said Oliver at AMP.
China’s benchmark money-market rates raced to record highs this week before sliding today after the central bank finally injected funds. The overnight repurchase rate dropped 442 basis points, or 4.42 percentage points, to 8.43 percent in Shanghai, according to a daily fixing compiled by the National Interbank Funding Center. That is the biggest drop since October 2007 and follows an unprecedented 527 basis point jump yesterday.
Among those likely to suffer the most from a weaker China: commodity exporters, which will experience a “double-whammy” of falling exports and prices, according to Tim Condon, head of Asia research at ING Groep NV in Singapore.
That puts Brazil, South Africa, and Australia under pressure. They all count China as their biggest trading partner. Data from China’s General Administration of Customs show Brazilian exports to the country fell 11.8 percent in the first five months of the year.
Gold Fields Ltd. and Sibanye Gold Ltd. were among the South African mining companies to decline this week. Brazilian oil producer OGX Petroleo & Gas Participacoes SA fell, as did BHP Billiton Ltd., the world’s largest mining company.
Asian neighbors will likely also be pinched, with Kowalczyk of Credit Agricole estimating Taiwan and South Korea rely on China to buy about a quarter of their exports.
China’s policy drive reflects a new departure in its economic management. Officials are more reluctant than they were in the past to loosen monetary or fiscal policies to check an economic slowdown. Instead, they are emphasizing the need for more-balanced growth in the longer term and policy changes to achieve it.
That reflects a focus on “the quality of growth rather than the quantity,” said Stephen King, London-based chief economist at HSBC. HSBC on June 19 cut its forecast for Chinese growth this year and next to 7.4 percent from previous forecasts of 8.2 percent and 8.4 percent.
A slower China may be a price worth paying if it results in an economy with more even growth that’s less prone to shocks, says Ken Courtis, founder of Tokyo-based advisory company Next Capital Partners and former Asia vice chairman at Goldman Sachs Group Inc.
China’s private debt soared to 168 percent of gross domestic product in the third quarter of last year, from 119 percent four years previously, according to Citigroup Inc. That jump is bigger than those of the U.S. and euro area in their pre-crisis years. The country also faces the potential for non-performing loans after lending a record 17.5 trillion yuan in 2009-10.
China “is imposing the type of tough medicine it needs to squeeze excesses out of the system,” said Courtis. “You can’t build long-term, sustainable growth if the system is not cleansed of excesses.”
It’s a view shared by David Loevinger, former senior coordinator for China affairs at the U.S. Treasury Department and now an emerging markets analyst in Los Angeles at TCW Group Inc.
“Slowing the growth in credit now increases the prospects for strong and steady growth later,” said Loevinger. “This is good for China and the world.”
Accelerations in the U.S. and Japanese economies also mean the world is “in a much better position to support a slowing China” these days, said Manoj Pradhan, an economist at Morgan Stanley in London. “A more-balanced China is something the global economy can absorb right now.”
If it helps ease commodity prices, it also could help reduce inflation elsewhere in the world, which is eating into consumers’ spending power, said Tim Drayson, global economist at Legal & General Investment Management Plc in London.
There may still be a pain barrier. While China’s leaders have been willing to let growth slow by more than some economists thought, a weakening to 7 percent would likely force a response, says ING’s Condon. Hensley at JPMorgan said possible responses to an extended soft patch could be lower reserve requirements or interest rates.
“I would be surprised if they allow this to go on much longer,” Nobel laureate Michael Spence said in an interview in Shanghai today.