I have for some time held the view that a dramatic and sudden drop in China's economic growth rate, a hard landing, is highly unlikely. Growth is decelerating to some sustainable long-term rate, but in a very managed and gradual manner. Xi and Li have unleashed a tough love policy to rein in excesses and encourage market-based growth, but Beijing has no desire to suffer the fallout from massive sudden unemployment and a dramatic decline in perceived economic well-being. There are many impediments to the success of economic restructuring, but I think the odds on at least a modest success in restructuring are higher than zero success.
But there is certainly a risk that I could be wrong in evaluating a number of widely documented risks, including debt, malinvestment, asset bubbles, etc.. This blog post briefly looks at how a sudden drop in China growth (a sudden drop to 3% for example) affects the rest of the world. I ran some scenario models on selected countries to help with this exercise.
China dependent and non-dependent countries.
Many warnings on China hard-landing scenarios focus on countries with direct trade ties to China. Commodities and capital goods are China's main imports (see my China trade info graphic for details), and countries that supply China will feel the effects of a drop in China demand. Countries such as Australia, Brazil, and Korea are commonly cited as countries at risk due to their sizable direct trade links to China.
But, China accounts for 14% of global output. Therefore, it is important to not overlook economies highly sensitive to global growth, even if the direct links to China are limited. If China drops, the global economy will slow significantly, and the effects will be felt by economies sensitive to global growth. Czech Republic is a good example. Czech is a workshop for Germany's massive manufacturing export machine. Exports are 80% of economic output in the Czech Republic, and many of these exports are components that end up in China and countries tied to China. Czech Republic growth will suffer significantly in a China 3% growth scenario, more than many other countries, even if it is halfway around the world with limited direct links to China.
Countries directly tied to China's trade demand are at risk. But, countries with high sensitivity to global growth and commodity reliant economies are at risk as well, even with no direct trade links to China.
The chart below shows the results of my scenario models forecasting the potential growth outcomes for selected countries.