All of this has economists upping their odds of a hard economic landing, a scenario where growth slows to a point that cause unemployment to spike.
For Société Générale’s China Economist Wei Yao, it’s not a matter of if China’s massive credit misallocation and debt will lead to a bursting of the bubble, but when and how the unwind will take place.
SocGen’s core China scenario has the world’s second largest economy seeing a bumpy landing, with growth slowing from 7.4% in 2013 to 6% in 2017.
But what about a “hard landing” where Chinese full-year real GDP growth rate plummets below 6%?
It’s possible, according to Yao. So what could trigger that scenario?
“First, the experience of 2008 showed that the Chinese economy is vulnerable to trade shocks,” Yao writes in a new letter to clients. “Second, a hard landing could be provoked by either insufficient public investment from Beijing or an intended credit deleveraging going out of control.”
And how would that crisis evolve?
Whatever the catalyst, the excess capacity in the manufacturing sector – estimated at 40% in 2011 by the IMF – would be exacerbated by a sharp growth slowdown. This would cut corporate margins sharply, making profits plunge, and triggering a downward spiral in domestic demand. Bankruptcies and unemployment would occur on a large scale, endangering financial and social stability. One factor that could accelerate the downward spiral is the high leverage of China’s corporate sector and local governments, which we estimate has reached 145-150% of GDP at end-2012.
Yao also theorizes how the Chinese government might respond to a hard landing.
The easier but more dangerous choice would be for Beijing to repeat the post-Lehman package of massive statedriven lending and investment facilitated by ultra-low interest rates and ample liquidity. However, such a solution would be less effective than in 2009 given the overhang in capacity, and would increase corporate leverage even further. A more judicious response would combine genuine tax cuts to lower the burden on the corporate sector, further liberalisation to give private enterprises new space to grow, more social spending to anchor consumption, and selective state investment to prepare China better for future challenges.
Here is one crisis scenario, where GDP drops to 3% and the government fails to stimulate the economy.
China’s imports are equivalent to 30% of its GDP, making it a huge driver of global demand. A hard landing would hit Asian economies the hardest, but could be felt everywhere.
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