There is a consensus that the Chinese economy is set to lose steam at a steady pace. This has manifested at an industrial level by an eroding profitability of Chinese firms. Recent data suggest that manufacturing profits stood at 14% during April, which is starkly down from the 23.8% in March. The YoY performance, nevertheless, has remained stalwart with a 24.4% growth in the 1st quarter of 2017. Fiscal spending has primarily fueled this growth and an overheated housing market and has been the actuator of demand in steel and cement sectors. This has allowed some chipping away of debt, but lately, the slowdown in industrial profitability is attributable to falling prices of finished products Vis a Vis stable raw material costs. However, with a credit growth cycle that has ballooned to 300% of GDP, if signs of rising debt persist further, led by capital misallocation, China’s sovereign rating may continue falling, which is a headwind for Global economic growth. Moody, to the scorn of Chinese lawmakers, just downgraded its rating from A1 to Aa3 and believes that countries restructuring reform agenda would not be enough to prevent the vicious borrowing cycle, that will continue to weigh on economic growth.
The ramifications of a slowdown in Chinese growth, and further downgrades has the potency to send serious shockwaves to the global economic growth and thus the financial system, given that China contributes almost 40% to Global growth rate. The contribution of growth from other major economies dwarfs that from China. For example, US, the world’s largest economy only contributed 2.2% during 2016 while Europe’s contribution was a measly 0.2% just higher that of Japan’s at 0.1%. This underscores the need for the Chinese economy to keep contributing strongly to the growth, in the absence of which global economic expansion will keep on falling short from its long-term target of 3.6%. Thus China’s growth rate remains not only a central point of discussion but pivotal to global growth rate, as any sort of hard-landing, meaning, a sudden deceleration of Chinese growth rate, has the effect of taking out at least 1% off of the global growth. This would pave the way to full-blown global recessionary conditions.
Moody’s Investor Service has remained cognizant of the steady slowdown, in face of mounting debt, and last month, downgraded its rating for the first time in 30 years. It expects that the country’s “vast reform agenda” would not suffice in curtailing sufficiently this high debt to GDP ratio. In the backdrop of this, it expects the growth to lose steam, eroding some the financial strength of the economy. After growing at above average pace at 6.9% during the first quarter of 2017, the rate of economic expansion is expected to slow down as the impact of stimulus begins to fade and borrowing cost rise; this albeit as the government targets riskier firms, in an effort to restructure the ballooning borrowing regime. Every percent decline in China’s growth rate knocks off 0.3% of global growth rate if spillover of foreign trade is taken into perspective. In addition, as Chinese economy restructures itself and moves away from manufacturing to services and consumption based economy, its domestic demand has the potency to raise the aggregate demand function of its trading partners, provided free market access is given. Thus, it becomes pivotal from a global perspective for a successful recalibration of Chinese economy because the consequential impacts would be a negative impetus to the global demand function.
Nomura, a Japanese holding company, maintains that hard landing, for now, may be a longshot, but expects growth retardation up to 6.2% by 2018. There is a plausible likelihood that government lead initiatives such as debt to equity swaps, mixed ownership programs, or tightened regulations in the shadow banking sector may prove insufficient to curb the unwarranted appetite of the economy, setting up a precedent for a financial meltdown. Even then, at least for now, this eventuality seems a little distant.