China is slowing down as some predicted several years ago. However, the big question now seems to be will it be a hard or soft landing? BAML is out with a new report on which countries will be impacted assuming there is a China hard landing. It is important to note they do not predict a hard landing, rather they examine who will be the hardest hit assuming it does happen.
China Hard Landing BAML
BAML China economist Ting Lu recently cut China’s GDP growth to 7.6% (from 8%) in 2013 and 7.6% (from 7.7%) in 2014). This comes on the back of sluggish external demand and a recalibration of base effects. They are not expecting China’s new policymakers to introduce any meaningful incremental stimulus. Neither is the PBOC expected to cut rates.
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China Hard Landing: the soft scenario
BAML maps out the trade, investment and other links to China across Asia. China’s slowdown or landing could send ripples through the rest of Asia. Their latest Fund Manager Survey ranks a China hard landing as the second most feared tail-risk, as China growth expectations turn negative for the first time in 14 years. BAML continues to hold on to the view of a China soft landing and does not foresee a hard land China scenario. Still, China’s modest slowdown is already having a dramatic impact on commodity prices. The structural decline in China’s potential growth towards 6% by 2020, largely because of ageing demographics, could also impact Asian countries most connected to China.
China Accounts For Over 10% Of World Trade
China accounts for over 10% of world trade compared with just 1% in 1980. Northeast Asia – Hong Kong (92% of GDP), Taiwan (17%) & Korea (12%) – have the largest trade links with China and are more vulnerable to a China slowdown (Table 1). This is followed by most of Southeast Asia – particularly Vietnam (9.5% of GDP), Malaysia (9.5%) and Singapore (8.5%). Countries less dependent include India (1%), Japan (2.4%), Philippines (2.5%) and Indonesia (2.5%).
China Hard Landing: FDI
China’s outbound FDI has been expanding only more recently and has not reached the magnitude of inward FDI (Table 2). But that figure will likely grow strongly in the coming decade, as China expands and diversify its interest abroad, given its fast growing size and large savings. Hong Kong stands out as most dependent on China for both China FDI (12% of GDP) and tourism (10% of GDP). The poorer Asian frontier economies – Laos (3.9%), Cambodia (2.3%) and Myanmar (1.2%) – are more reliant on China FDI (Table 3). On China tourism, HK sees the largest impact (10% of GDP), while Cambodia, Thailand, Vietnam, Taiwan and Singapore see some small share (about 1% of GDP). China tourism is negligible for India, Japan, Indonesia and the Philippines.
A China hard landing scenario will hit Asian countries with greater FDI invested in China. Magnitude of Asian FDI in China is larger than that of FDI from China into the rest of Asia, but that trend may reverse by the end of this decade (Table 4). FDI into China is disproportionately large from Hong Kong. Round-tripping because of tax arbitrage may be a reason. Other Asian countries with sizable FDI into China include Japan, Singapore, Korea and Taiwan (Table 5).
There are other channels in which slower China growth could reverberate across Asia. Commodity price is one clear transmission shock. China accounts for a large fraction of coal, soybean, and iron ore trade (about 20%, 60% and 70% respectively as % of world imports). Small changes in China demand may thus have large effects on import demand and commodity prices. Indonesia’s current account has swung into a large deficit (2.7% of GDP in 2012) from a surplus because of plunging export prices.
The currency channel is another. The 1994 devaluation of the Chinese yuan (by about 50%), some claim, was partly responsible for Asia’s crisis and the subsequent traumatic devaluations. So far, the yuan has largely stood aloof, appreciating 1.5% this year, while many other Asian currencies have tumbled (partly because of a plunging yen). BAML see the yuan appreciating by 1.5% to RMB6.05/$ by year-end, remaining an anchor for Asia despite China’s slower growth. How the sharp JPY depreciation could have knock-on effects on bilateral trade balances and Asia’s currencies remains to be seen. But Japan’s QE should have both a reflationary and portfolio impact across Asia, and not just a beggarthy-neighbor exchange rate effect.