What The Great Chinese Debt Unwind Means For 13 Emerging Markets

China chinese love dating game showREUTERS/Carlos Barria25-year-old Liu Tingting introduces herself during the recording of an episode of ‘Meet you on Saturday’, a matchmaking television programme, at a local television station in Shanghai, July 28, 2013.

Chinese economic data has been better than expected in July. During the month, industrial production
rising 9.7% year over year, exceeding economists’ forecasts.

But positive July figures have not fully allayed investor fears that the Chinese economy will continue to decelerate.

In a note titled “The Great EM Unwind,” Morgan Stanley’s Manoj Pradhan and Patryk Drozdzik lay out how some of 13 Emerging Market countries (EM) could lose and how some could win when China slows down.

“We identify three channels through which China’s deleveraging is likely to affect the rest of EM: i) The trade of manufactured goods; ii) The trade of commodities; and iii) The impact of a slower Chinese economy on the terms of trade,” they wrote.

“In the pre-crisis decade, China’s re-export model and its strong domestic growth helped to improve EM current accounts,” they added. “As China deleverages amid a weak export cycle, EM economies stand to export less to China and are therefore likely to see more current account deterioration (with some exceptions due to terms of trade effects).”

From Brazil to Turkey, some emerging markets with large China exposure will be hit hard, while others stand to benefit.

The analysts also discuss the impact of countries domestically scaling back debt as well as how they would be impacted by the U.S. unwinding quantitative easing. We pulled the points that highlight the impact of China.

Brazil's growth will be pushed lower

'Brazil's investment cycle has been closely linked to the positive terms of trade it faced. Weak terms of trade will hurt investment and consumption, pushing growth lower. A silver lining of the unwind of the terms of trade shock could be a more competitive manufacturing sector, but the exchange rate and real wages have to weaken a lot for that to happen.'

Brazil's domestic bond market has so much foreign ownership that it also leaves the country exposed to external shocks.

Source: Morgan Stanley

India stands to benefit

'A net beneficiary of a China slowdown due to low exposure via exports and a large net import position for fuels and hard commodities that could benefit from better terms of trade.'

India had strong credit in the wake of the crisis, but has since slowed with nominal GDP growth.

Source: Morgan Stanley

Indonesia's exports would continue to suffer

Falling commodity prices have hurt this commodity exporter already and created a current account deficit. A further fall from a China slowdown would aggravate the problem.'

The account deficit has meant Indonesia has been forced to 'tighten policy to defend its currency.'

Source: Morgan Stanley

Malaysia will get hit with a one-two punch

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'Dual headwinds like all commodity producers, with 13% of exports going to China and Malaysia exporting both oil and hard commodities.'

Malaysia's credit-to-GDP ratio stands at 120%.

Source: Morgan Stanley

20% of Peru's Exports Head To China

'Exposed to China for sure with 20% of its exports going there, but the cost of extraction of copper is 50% that of other locations, and much of the capex is yet to come, which means excess capacity is not as much of an issue.'

Peru has had double-digit growth in private sector credit.

Source: Morgan Stanley

It will be a wash for Poland

'Very few links with China. Poland is a net importer of oil but a net exporter of hard commodities so that the terms of trade effect is likely to be mixed.'

Poland has been resilient lately, but is moderately exposed to external balance sheet shocks.

Source: Morgan Stanley

Russia faces an export risk

'Russia's oil and hard commodity exports are at risk from China, but trade links are very weak.'

Russia's strong deposit growth implies lower risk for unwinding EM credit.

Source: Morgan Stanley

Taiwan could benefit from falling commodity prices

Highly exposed via exports (more than Korea); will benefit from falling commodity prices.'

Taiwan is one of the EM countries least exposed to unwinding quantitative easing.

Source: Morgan Stanley

So could Thailand

'About 12% of Thailand's exports go to China, which creates downside risk. However, our AXJ team believes that Thailand's status as a net commodity importer will mean a net benefit from lower commodity prices.'

Thailand's loan-to-deposit ratio is high due to credit growth from 'populist lending measures.'

Source: Morgan Stanley

Turkey, which imports oil, could benefit from a weaker China

'Turkey is a net beneficiary from a China slowdown. It has very weak trade links with China but is a large importer of oil and hard commodities that could benefit from weakness in China growth.'

After excessive credit growth in 2011, Turkey needs to keep it 'under control.'

Source: Morgan Stanley

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