The recent slowdown in the Chinese economy and the sharp falls in its stock market over the summer have sent shock waves rippling across global markets, and reignited fears of another downward leg to the global financial crisis. But how bad are things really? And what does it mean for other economies around the world?
China has serious challenges to address
The Chinese economy clearly faces some real problems as discussed in our latest Global Economy Watch report. Total private credit has risen to around 140% of GDP, one of the highest in the world and well above what you’d expect to see based on average income levels (see Figure 1). Added to high levels of debt in local government and some state enterprises, this is a problem that will take some years to resolve as the Chinese authorities seek to ease debt levels down to more sustainable levels without triggering a hard landing for the economy as a whole.
Figure 1: Chinese domestic credit level one of the highest in the world relative to GDP
Source: PwC analysis using IMF and World Bank data
The country is also grappling with a debt-fuelled property investment bubble that has burst, as I talked about in a blog back in January. Having lost faith in property, some Chinese investors seemed to have moved into equities, but that bubble has also now burst, as we’d seen with the stock market falls over the past few months. Most forecasters still expect a slowdown rather than a hard landing in Chinese GDP growth, and that’s our view too - but there are clearly more downside than upside risks as the IMF has said.
Chinese export growth was also hit by a real appreciation of the yuan while it was linked to the dollar (which has been very strong), making Chinese goods less competitive. This has been reinforced by relatively high Chinese wage growth in recent years. The recent policy of allowing the yuan to fall against the dollar is aimed in part at restoring some of this lost competitiveness, as well as making the yuan more responsive to market forces. The yuan may well have further to fall against the dollar.
Now let’s take a look at the impact of China’s slowdown on the rest of the world.
Not so bad for Europe and the US…
One impact of the slowdown in China has been to lower oil prices (and other commodity prices as discussed further below). This is good news for net oil importers like the Eurozone, where a gradual recovery has been underway this year, helped also by QE by the European Central Bank. We therefore expect a gradual return to growth for the Eurozone, but at a relatively modest rate of around 1-1.5% per annum, especially with the effect of a Chinese slowdown on German exports. UK growth should be stronger at around 2.5%.
On the US front, the latest evidence suggests that growth is continuing, although at a more moderate pace than hoped for at the start of the year - around 2.5% rather than over 3%. Given the problems in China, the Fed seems likely to hold off raising interest rates until at least December, but a gradual rise is still likely to start then or early 2016. An eventual rise in US rates is widely anticipated by the markets and has been another factor in weakening some emerging market currencies relative to the dollar this year.
… but emerging markets dependent on commodity exports are suffering …
Slower growth in China has cut its demand for commodities from some emerging economies that are large net commodity exporters like UAE, Saudi Arabia, Russia, Chile, Nigeria, Colombia, Malaysia, Argentina, Indonesia and Brazil as shown in Figure 2 below. But some other emerging economies, notably India, will gain from lower commodity prices, as will China itself as a significant net importer.
Figure 2: Leading emerging economies have different exposures to ‘lower for longer’ commodity prices
Source: PwC analysis of data from IMF and UNCTAD
Slower than expected growth in Chinese demand has added to downward pressure on global oil and other non-food commodities prices. Together with supply factors (e.g. Iranian oil supplies coming back on stream as US sanctions are lifted) we think this could keep oil prices low for longer. Currencies of emerging markets that depend on oil and other commodities have fallen accordingly.
… and Asia-Pacific economies with close trading links with China will also be hit
As well as commodity producers, other economies in the Asia-Pacific region that rely on exports to China for a relatively high proportion of their GDP are also being adversely affected. This includes advanced economies like Singapore, Taiwan, South Korea and Australia, and emerging economies like Malaysia, Thailand and the Philippines.
But we don’t think a rerun of the Asian crisis of 1997-98 is likely. At the time, countries like South Korea, Thailand and Malaysia were running significant trade deficits, whereas now they’re generally running trade surpluses and have built up defensive stocks of foreign exchange reserves. This is in contrast to some other emerging economies such as Brazil and South Africa that look more vulnerable due to running significant trade deficits in recent years, as well as being exposed to declines in commodity prices as noted above.
Conclusion: watch with care but don’t lose sight of longer term growth potential of emerging markets
So we think events in China are of concern and need to be watched carefully. Some other emerging markets also face serious challenges. Businesses and investors need to be selective in targeting emerging markets and be prepared to ride out some turbulent times in the short term.
But we shouldn’t lose sight of the longer term growth potential of these markets, which is still considerable as argued in our World in 2050 report earlier this year and in our Growth Markets Centre research. Emerging markets may be slowing but, as a group, their longer term growth rates are still likely to be significantly higher than in mature markets like the US and Western Europe.
John is Chief Economist for the UK and editor of the Economic Outlook publication, and many other reports and articles on macroeconomic and fiscal policy issues. He has over 20 years of experience as an economics consultant to leading public and private sector organisations, both in the UK and overseas. Read more