What’s happening in global markets right now is not just about risk for people who own stocks and are betting on China.
As noted earlier the risk is that China’s slowdown combined with its currency devaluation could trigger a range of consequences for emerging market economies around the world, feeding a vicious cycle of falling competitiveness and income.
Here’s how Societe Generale warned about the potential spillover (even though this is not what they expect, on balance, to happen):
Critical to our outlook is global market confidence; should equities, bond spreads, commodities and emerging currencies suffer further sharp and significant losses across the board from here, then a self-fulfilling vicious circle of default, forced asset sales, further price declines … and ultimately recession … could result.
Asia’s emerging markets have already been suffering from declining export volumes. China devaluing its currency will not help on this front, and many of them have borrowed heavily in US-dollar loans which are going to increase in costs when the US Federal Reserve starts raising interest rates, something expected in the coming months.
If they borrowers have not swapped some of this debt into their home currency, a Fed tightening means Asian borrowers will owe more if the debt is not hedged.
The two themes – the China slowdown and the impending tightening from the Fed – combine to create a very grim outlook for some emerging economies. Morgan Stanley, in a note to clients today, says:
In recent months, both these pressure points, particularly the growth slowdown in China, have only accelerated the adjustment process – turning it into a painful macro environment for the region. We have held the view that these two trends are posing systematic downside risks to the region’s growth outlook. We believe that all the countries in the region will be exposed to at least one of these two trends, if not both.
The chart below from the note maps out the Asian economies Morgan Stanley believes are most exposed to the two huge forces at work in the global economy at the moment.
Korea, Australia’s fourth-largest trading partner, is the most exposed to the China slowdown. And Indonesia, Australia’s vast northern neighbour, is exposed on both fronts. Indonesia’s share of US-dollar external debt is 72%, the highest of the emerging Asian economies.