China's slowdown reveals Asia's vulnerability
As China's GDP growth continues to slide, its Asia-Pacific neighbors are starting to feel the pain. The regional impact depends on how much-and how fast-China's economy slows. IHS analysis of a China hard landing provides insight into just how serious the consequences could be.
The rapid growth of the Chinese economy over the last decade has resulted in China's share of world gross domestic product (GDP) rising from 5% in 2005 to an estimated 15% in 2015. This has made China an increasingly important export market for many Asia-Pacific countries. In 2014, China accounted for 35% of Australia's total exports, 25% of South Korea's, and 20% of Japan's. Exports to China from the Association of Southeast Asian Nations (ASEAN) have grown at a pace of approximately 20% a year over the last decade.
China's growing prominence as a market for exports from its Asia-Pacific neighbors, however, has increased their vulnerability to a Chinese economic slowdown. The pace of Chinese economic growth has moderated significantly in recent years, falling from 10.6% in 2010 to 7.3% in 2014. IHS expects a further easing in growth momentum in China, and is projecting GDP growth to be approximately 6.5% this year, and 6.3% in 2016. This slowdown reflects both a structural shift due to a gradually aging population, moderating productivity growth, and a cyclical slowdown following the growth surge from 2009 to 2011, which was the result of the large fiscal and monetary stimulus package implemented during the global financial crisis.
Significant imbalances in China's economy have also played a role in slowing growth over the last three years and have made the economic outlook more uncertain. Between 2010 and 2013, cheap credit and a ballooning shadow banking sector resulted in a massive increase in new lending-including for new housing construction-which led to a surge in the residential real estate market. When Chinese authorities introduced tightening measures to prevent a real estate bubble, the residential property market began to cool, resulting in oversupply and high vacancy rates in some Chinese cities. This, in turn, led to steep price discounts on new properties in 2014 and 2015, as well as to rising default rates among smaller property developers. Although residential property sales showed signs of stabilization in mid-2015, the inventory of unsold residential properties is currently estimated to be above its long-term average. New residential floor space starts fell by 17.3% in the first six months of 2015 compared with the same period a year ago, and total land area purchased by real estate development enterprises was down by 33.8% in the same period.
Likewise, China's industrial sector has significant excess capacity in many key sectors. Estimates of excess capacity in these sectors of manufacturing from 2013-the most recent year of government audit data-show the rate hovering in the mid-20% range.
The significant excess capacity in key industries has reduced the need for new investment in these sectors, which face restructuring through closures, consolidations, and relocations. This is acting as a further drag on China's fixed-asset investment growth, which has slowed from a pace of 19.6% growth in 2013 to 10.9% for the first eight months of 2015, compared with the same period a year ago.
The Chinese economy is also undergoing a significant structural transition from manufacturing to services, as rising household incomes are driving a higher share of consumer spending toward expenditures for items such as financial services, health care, and business services.
Other signs of China's economic moderation are reflected in high-frequency economic indicators such as industrial production and retail sales, as well as in China's purchasing manager's index (PMI) for manufacturing. For example, the Caixin/Markit PMI for August 2015 declined to 47.3, the lowest reading since March 2009, and the flash estimate for September fell further, to 47.0. The official Chinese PMI for manufacturing was slightly higher than the Caixin/Markit PMI in August, at 49.7, but was still the lowest reading for this index since August 2012. The September reading barely budged upward, to 49.8.
Chinese exports showed large year-on-year declines of 8.3% in July 2015 and 5.5% in August 2015. The Chinese auto industry has also experienced a significant reduction in sales, with August auto sales down 3% year-on-year, the third consecutive month of decline. For 2015, IHS estimates that Chinese light vehicle sales will be 23.4 million, just 1.4% higher than in 2014.
Implications for the rest of Asia
Signs of weakness in Asia-Pacific exports and industrial production are becoming increasingly apparent. During July 2015, exports from India, Indonesia, Singapore, South Korea, Taiwan, and Thailand all contracted on a year-on-year basis, with most of these economies having reported declines for August as well. While these declines are not attributable solely to China-other factors, such as weak Japanese import demand, have also contributed to the Asian export slowdown-exports from many of these economies to China did drop significantly during July and August. Taiwan's exports to China fell by 16.6% year-on-year, South Korea's by 8.8%, and Japan's by 4.6%, according to August trade data. While Japanese export growth-helped by a depreciating yen-remained positive in July and August on a year-on-year basis, the momentum is slowing due to weakening exports to China.
Indonesian commodity exports are suffering from the combined effects of lower global commodity prices and weaker Chinese import volumes for Indonesian thermal coal. Total Indonesian coal export volumes declined by 18% from January to August compared with the same period in 2014, with export volumes of thermal coal to China falling by 49% in the first six months of 2015 compared with the same period a year ago.
Similarly, Singapore's exports fell by 10.8% year-on-year in August, with large declines in exports to China, South Korea, and Taiwan.
India's export sector has also been hit. For the first half of 2015, the country's exports to China fell by 24% compared with the same period of the previous year. India's total exports in August were down 21% year-on-year.
Against this backdrop of declining exports for many Asian countries, there has been considerable concern about the impact of China's yuan devaluations in August. Many Asian countries fear that further devaluations could erode their relative competitiveness against Chinese exports.
Several Asia-Pacific countries that have seen their exports decline recently are also experiencing declines in industrial production. Taiwan's export sector slump, for example, has already resulted in a 3.0% drop in July industrial production year-on-year and has contributed to a weak GDP growth outturn for the second quarter of 2015, with GDP growth up just 0.64% year-on-year, the lowest pace of growth for 11 quarters. With exports accounting for about 54% of South Korea's GDP, the South Korean industrial sector has also been hurt by the country's overall slump in exports, down 14.7% year-on-year in August. This has been an important factor underlying the country's decline in industrial production, which fell by 3.3% year-on-year in July. Japanese industrial production was flat year-on-year in July, with shipments to China down 1.3% year-on-year in volume terms, while shipments to the rest of Asia were down 0.4%.
In Southeast Asia, Singapore and Thailand continued to show negative growth in industrial production in July on a year-on-year basis. Singapore's industrial output fell by 6.1%, dragged down by weakness in electronics production as well as in transport engineering. Output of the transport engineering sector was down 9.2% year-on-year for the first seven months of 2015, with declining activity levels in rig-building and shipbuilding activity.
Unlike the East Asian economies, whose industrial sectors are heavily dependent on exports, the Indian and Indonesian industrial sectors are more oriented to domestic production. Thus, the negative export growth for both countries year-on-year in July is not reflected in their industrial output over this period.
Meanwhile, forward-looking manufacturing surveys also indicate difficulties for the industrial sectors of many Asia-Pacific countries. According to the August Nikkei/Market Asia Sector PMI report, output has continued to contract for Asian manufacturing sectors including metals and mining, chemicals, autos and auto parts, household and personal use products, machinery and equipment, and construction materials. By contrast, many of the sectors showing the biggest expansion of output in August were in services, including insurance, software and services, healthcare services, and commercial and professional services. Taiwan's PMI index for manufacturing declined to 45.0 in August while the index for new orders fell sharply to 39.9. Both figures were the lowest since July 2012. The Nikkei South Korean PMI for manufacturing was also weak in August 2015, at 47.9-the sixth consecutive monthly reading signaling contraction in Korea's manufacturing sector.
What if China has a hard landing?
The biggest danger to the Asia-Pacific region from the slowdown in China's economic growth would come if the country experiences a "hard landing," in which GDP growth sinks below 5.0% for the year. While the IHS baseline forecast still predicts a soft landing for China, with GDP growth of 6.5% in 2015 and 6.3% in 2016, certain imbalances in the Chinese economy have increased the risk of a hard landing.
In addition to the residential construction downturn, excess capacity in key manufacturing industries, and financial sector instability related to the rapid expansion of commercial bank and shadow bank lending since the global financial crisis, significant imbalances in the Chinese economy include the recent stock market boom and subsequent crash. Considering all of these factors, IHS estimates the probability of a hard landing for China over the next two to three years at around 25%.
Using the IHS Global Link Model of the world economy, IHS has recently analyzed and assessed the effects on other countries-both in the Asia-Pacific region and worldwide-of a protracted Chinese hard-landing scenario in which China's GDP growth averages only about 5% a year, considerably lower than the IHS baseline forecast. In this scenario, the IHS Global Link Model simulation shows that a China hard landing would have a severe negative impact on the Asia-Pacific region.
The main transmission channels for the economic shock waves would be trade, investment flows, commodity prices, and exchange rates. The consequences for international trade would have the most immediate and severe impact on the global economy, as China now accounts for approximately 15% of the world's total real GDP, as noted above; the impact on trade would touch virtually every product type and country.
Countries with the broadest trade exposure to the risk of a hard landing are China's East Asian neighbors. In the manufactured goods sector, a number of East Asia's largest manufacturing exporters-including Japan, South Korea, and Taiwan-export a significant share of their total output to China. China is also a key export market for many Southeast Asian economies, including Malaysia, Singapore, and Thailand. Given an increasingly integrated East Asian supply chain for manufacturing, weakness in key Chinese manufacturing sectors such as autos-where China is the world's largest producer of light vehicles-would have flow-on effects to other Asian countries that export raw materials and intermediate goods to these sectors.
With a broader slowdown in the growth of emerging markets also in progress, economies in the Asia-Pacific region are facing a number of headwinds to economic growth and exports. While strong growth in the US economy-particularly in US consumer spending-is a bright spot in the global growth landscape for Asian exporters, the China slowdown and broader weakness in many emerging markets is acting as a drag on their near-term economic outlook.
The Asia-Pacific region is expected to weather China's slowdown if China's GDP growth remains above 6% over the near term. However, a hard-landing scenario in which Chinese GDP growth drops substantially below its current rate would pose a serious risk to the economic outlook for the region in 2016 and beyond.
Rajiv Biswas is chief economist, Asia-Pacific, IHS Economics
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