What if I am wrong about a hard landing? What countries are at risk and what countries should we not worry about?

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. 

Google Visualization API Sample
Source: IMF Database, LaoHu Economics Blog Scenario Models

The five least at-risk economies in my scenario models:

  • Indonesia - My scenario model results show Indonesia as the least sensitive economy to a China hard landing.  Household consumption and investment are the two biggest drivers to growth.  60% of economic growth is household consumption.  Exports are roughly 23% of GDP, very low by EM Asia standards, and shipments to China are not meaningfully large.  With a very low level of capital stock and 39% of its labor force employed in agriculture, investment and productivity growth are more important factors than China growth.  However, Indonesia's external positions, as measured by the country's current account, will worsen in a China 3% growth scenario.
  • Uruguay - China is Uruguay's second largest trading partner, after Brazil.  But, the vast majority of exports are agricultural, and less sensitive to growth declines than industrial commodities and energy related commodities.  Of the countries tested in my scenario analysis, Uruguay is the second least sensitive country to a China hard landing.
  • Canada - 76% of Canadas exports go to the US.  The country is the 5th largest exporter of crude oil, but oil only comprises 17% of Canada's exports.  Exports are much more diverse than commodity exporting peers.  
  • Philippines - The country's two largest export destinations are Japan and the US.  32% of the labor force is employed in agriculture.  Household consumption is over 70% of output. Domestic growth is a much more important driver of output than external trade.  And, much of the country's external demand is in the form of services to developed countries.
  • Mexico - 78% of Mexico's exports go to the US.  Only 6-7% of exports are energy related commodities.  The potential deterioration in Mexico's current account, according to my models, is minimal.

Aside from well-known direct commodity suppliers, like Australia and Brazil, who else is at risk in a 3% China growth scenario?

  • Singapore and Czech Republic have a high sensitivity to global growth.  Both will see meaningful declines in a 3% China GDP growth scenario.
  • Singapore, Nigeria, Chile, Russia, and Peru will see very large drops in external positions (as measured by current accounts) in a 3% growth scenario based on my models.
  • Countries with close trade ties at risk in a 3% scenario: 
    • Mongolia (30% of GDP exported to China)
    • Malaysia (19% of GDP exported to China)
    • Korea (15% of GDP exported to China)
    • Taiwan (16% of GDP exported to China)

See the maps in the link below to get a picture of who supplies China.