The growing risk of a hard landing for China’s economy would result in global growth weakening by an average of 0.4 percentage point annually over 2015-17, according to a scenario developed by economists at IHS Inc., (NYSE: IHS), the leading global source of critical information and insight.
The IHS economists developed the scenario because of the greater prospects of China’s GDP growth slowing substantially if the asset bubbles that have been building there finally burst.
The IHS scenario assumes a severe tightening of credit conditions following the crash of the housing market and default by major real estate developers, and also assumes a drop in confidence by domestic and international investors. This is followed by cutbacks in fixed investment and consumption, a slowing of real exports of goods and services, and a significant erosion in domestic demand, causing China to experience deflation in 2015. Rather than holding near 7.5 percent as expected, China’s real GDP growth downshifts to 6.6 percent this year and 4.8 percent in 2015, before gradually reviving.
While the impacts by country and region vary significantly, the scenario developed using a new, state-of-the-art IHS Global Link Model— has a one in three probability of occurring and notes that a Chinese hard landing would lower world GDP growth by 0.1 percentage point in 2014 and 0.5 percentage point in both 2015 and 2016. By the end of 2016, the level of world GDP is 1.2 percent lower than had China not experienced a hard landing.
“By connecting the dots using our extensive global economic modeling resources, it is apparent that if China sneezes, the rest of the world catches a cold, and for some countries that could develop into economic pneumonia,” said IHS Chief Economist Nariman Behravesh. “While the largest impact would be felt in Asia among China’s nearest trading neighbors, no country or region would escape fully unscathed.”
Japan’s real GDP would be 1.1 percent lower by 2018, while Australia’s and Indonesia’s real GDP would be down 2.2 percent and 1.8 percent, respectively. But other regions would not be immune, such as Latin America, Africa, and the Middle East, where many countries are key suppliers of agricultural, industrial, and energy commodities to China. For example, real GDP in Saudi Arabia would be 0.8 percent lower by 2018, due to the spillover effects of lower revenue from oil exports.
By comparison, the impact of a Chinese hard landing is more subdued in North America, and Central and Southern Europe.
IMPACT ON MIDDLE EAST OF CHINA SLOWDOWN
“A China hard landing would mean the Middle East would experience weaker exports, lower tourism and business activity, and probably a resurgence of risk aversion by global companies due to this new deterioration of the global economic situation, just at the moment when they thought the situation was finally improving,” said Behravesh.
“In an even weaker growth scenario than we’ve outlined, if China’s economy slowed to 3-4 percent, then oil prices might fall to perhaps USD $50-60 per barrel,” he added.
“A hard landing in China would mean real GDP will be slower in the Middle East in the short run, but IHS does not expect the slowdown to have major long term consequences on growth in the Middle East, Behravesh said. “The growth slowdown would be a few decimal points, with the real GDP level in Saudi Arabia down by 1 percent in 2018, for example.”
Although a China hard landing would have direct implications on oil prices and exports to China, the implications on growth in other countries and regions, particularly in Europe, are also significant. Slower growth globally means weaker energy demand globally. Also, a China slowdown would have consequences on the future choices of financial investors. Lastly, tighter monetary conditions are expected in several emerging markets, such as Turkey, which have close ties with Middle East countries.
The scenario also examines ways in which an economic slowdown in China affects specific markets of the global economy.
First, China’s demand for imports falls as economic activity slows. Imports of non-agricultural commodities, energy, and manufactured goods—and the countries exporting those goods and products to China—suffer significant setbacks. That includes Chile and Malaysia, exporters of raw materials to China, and South Korea and Japan, as well as most of the European countries leading the continent’s growth—Germany, the United Kingdom, Slovakia, and several Scandinavian countries—all of whom are big exporters of manufactured products and equipment to China.
Second, as China’s economy slows, so too does global demand for commodities. Prices for several commodities fall. Comparing the scenario with the IHS baseline forecast, aluminum prices are 2.1 percent lower in 2014 and 13.5 percent lower in 2015; copper prices are 2.2 percent lower in 2014, but 16.8 percent lower in 2015; and iron ore is expected to be 7.4 percent lower in 2014 and 29.7 percent lower in 2015. Prices for cotton, coffee, and, to a lesser extent, wheat are also affected.
Lastly, global exchange rates would also be affected. Because several emerging markets are highly dependent on China for capital inflows to finance their current account and help finance their debt, slower growth in China causes financial investors to back away from riskier markets, which puts pressure on exchange rates and causes many countries to raise interest rates to prevent further capital outflows.
When these three factors are combined, the net result is a weaker growth path worldwide over the next three to four years, and heightened risks in several areas of the globe.