While most investors still expect the Chinese government to navigate its inflated GDP growth rate and cool the economy down gradually, a recent Societe Generale survey found that there is more concern about the tail risk of a hard landing.
“In our core scenario, we see Chinese growth decelerating gradually – though at a slightly faster pace than the consensus anticipates – to 5.5% by 2018,” writes Societe Generale head of research Patrick Legland.
Half of China’s GDP growth from capex
The main challenge that Legland sees facing China is that it is still getting nearly half of its GDP growth from capex, and a lot of that spending is just the inefficient use of loose credit. As credit tightens due to stricter liquidity conditions, shadow banking regulations, and new rules against local government borrowing, many of these investments are expected to fail. China’s credit markets would then have to write-down all of the bad loans that are currently floating around due to lack of fiscal discipline. If that leads to a run on local banks and large scale corporate bankruptcies, China could face serious contagion.
8% think a China hard landing is a realistic scenario
It seems unlikely that China will escape from this credit bubble completely unscathed, but so far investors are still confident that it can navigate through without a sharp downturn. Societe Generale has found that investors believe, on average, that the worst-case scenario is for Chinese growth to hit 5.6% (down from 6% last year), but the change in the distribution is more telling. The tail responses have increased, with 8% of investors saying that Chinese growth could fall below 3.5%, compared to just 4% of respondents last year. So it’s not that the average investor has lowered their targets, but a subset of investors now think there is a realistic possibility of a sudden drop.
There is also a much lower expectation that the Chinese government would fight the downturn with a new stimulus package, possibly because the government has spoken plainly about its desire to get credit under control over the last year. The biggest change is among US investors, who almost unanimously said that China would respond to a hard landing with a stimulus package last year (possibly projecting their own domestic experiences), but are now the most bearish on the idea. Asian investors’ expectations were unchanged, possibly because they have paid closer attention to Chinese government pronouncements over the last few years.