Talking Point

China’s eurozone worries

Beijing ponders whether it can hold ‘steady’ if Europe triggers crisis

“Look, this is serious”: China’s central bank governor Zhou Xiaochuan and IMF boss Christine Lagarde

“Stay steady to deal with all the changes around you” is a maxim that generations of Chinese Zen Buddhists have practiced.

Beijing policymakers must be pondering it these days too. Last week the escalating eurozone crisis, combined with a remark from the Fed about the deteriorating state of the American economy, were enough to send financial markets sharply lower. The sense of panic was palpable. At the IMF World Bank meeting over the weekend, Treasury Secretary Tim Geithner didn’t mince his words. He spoke of “the threat of cascading default, bank runs and catastrophic risk”.

Indeed, with the IMF warning that Europe’s banks need recapitalising to the tune of €300 billion and financial markets pricing in an almost certain Greek default, the mood was grim in Washington. Financial Times columnist Wolfgang Munchau noted: “I have never seen Europe’s policymakers as scared as I saw them in Washington last week.”

Amid this storm stands China, one of the last pillars of growth in the world economy. Can it stay “steady” in the midst of the turmoil or will the eurozone drag China into crisis too?

Okay, can China build a wall?

Bloomberg TV has begun to use the descriptor “mammoth” whenever it refers to China’s economy these days. It’s a word that conveys a sense of scale and strength. But can the Chinese economy – which has enjoyed double digit growth for the past 30 years or so – insulate itself from events in Europe and the US?

Some take solace from Beijing’s track record in managing its economic affairs. “The key thing is that businesses like certainty and the global economy is full of uncertainty,” Martin Cubbon, the CEO of Swire Properties told Bloomberg this week. “The government gives you as much certainty here [in Beijing] as is possible. I’d rather be here right now.”

However, it is also clear that Chinese policymakers are increasingly worried by the downward drift in the global economy, and that the divisions, dithering and delay in the eurozone has unsettled even Beijing’s more unflappable types.

The governor of China’s central bank, Zhou Xiaochuan, told fellow delegates at the IMF World Bank meeting at the weekend that “forceful measures” were required to solve the European sovereign debt crisis. Eurozone states needed to “put their domestic houses in order”.

Shen Danyang, Ministry of Commerce spokesman, likewise predicted that the consequences of inaction would be dangerous. “As the debt crisis worsens… trade frictions will grow,” he said (possibly thinking of similar problems in the 1930s, when escalating tensions drove the global economy into a depression).

Plunging confidence in Europe’s ability to sort itself out is also showing up in the Chinese media.

Shanghai Security News told readers that “if the economies in Europe once again go into recession, China’s economy may face a greater risk. But if Europe and the US go into severe recession, China’s exports will decline 15% and the GDP growth rate will be reduced to 7%.”

The newspaper calculates that for every percentage point that Europe’s growth falls, China’s export growth recedes by six percentage points. Some industries will be particularly hard hit. On a 2% decline in European growth, Chinese shipping firms revenues decline 13%, air transport revenues fall 11% and the telecommunications equipment industry sees a drop of 10%.

China Securities Journal thinks there are “strong expectations” of a global economic recession once again, and that the statistics already show that Chinese corporate earnings are “deteriorating”. It notes that net profit for China’s listed (non-financial) stocks grew only 9.9% year-on-year in the second quarter, versus 18.9% in the first.

So still growing, yes, but at a weaker pace.

Further evidence of slowdown was evident in HSBC’s flash data for September’s purchasing managers index: a score of 49.4 compared to 49.9 in August. Any figure below 50 indicates a contraction in manufacturing. In China’s cases that almost always means falling GDP growth.

How can China deal with the crisis?

HSBC’s chief economist, Qu Hongbin remains sanguine that China retains sufficient policy options in its arsenal to ride the crisis out. Thanks to the fact that inflation is “cooling” he also sees the government as having more leeway for adjustment. In a note released on Wednesday he forecast: “Beijing can and will respond if there is a new global recession. But we don’t expect a repeat of the massive 2008-09 stimulus package.”

That’s because the Chinese government won’t want to “repeat the mistake of over-stimulating the economy, which brought inflation, property overheating and local government debt risk”. Likewise, it helps that Chinese growth is now “much less export driven”, and hence less exposed to the diminished wallets of consumers in Europe and the US.

By Qu’s calculation: “Net exports made almost zero contribution to China’s 9.6% GDP growth in the first half of 2011, implying the impact of a global recession will be much smaller this time.”

In fact, HSBC forecasts that Chinese GDP should still grow 8.9% this year and 8.6% in 2012. But any additional spending – to stimulate the economy – will likely be considerably smaller than Beijing unleashed in 2008. For example, he forecasts less than $200 billion will be required to keep Chinese growth at HSBC’s target levels. Should stimulus be required, he suspects more government funds will be spent on public housing and to support small and medium-sized firms.

In fact, Qu’s colleague Steven Sun even offers a bullish outlook on China’s stock market. HSBC’s head of China equity strategy published a report late last week predicting that the A-share market could once again prove to be a leading indicator. In 2008 the Chinese stock market led the global equities rebound (by around four months) and Sun reckons this may happen again, describing valuations as “distressed” and “overly-pessimistic”.

Taking a (perhaps) contrarian view, Sun believes the Shanghai Composite Index has bottomed and could hit 3,000 by year-end (it was hovering around the 2,400 level at the beginning of the week). The leadership transition next year, plus an easing in inflation, could also be factors. There was a similar dynamic, Sun points out, in 2002 ahead of the last leadership change.

In the meantime, market sentiment remains fragile. Sinohydro scaled back its Shanghai IPO this week – cutting the number of shares offered as well as pricing at the bottom of the range. The dam builder raised Rmb13.5 billion ($2.1 billion) which was 22% less than it had initially targeted.

Some certainty please…

In spite of a relief rally in global markets at the start of the week, it remains to be seen whether Europe’s leaders can come up with more concrete plans to contain the eurozone’s debt crisis.

In China – like the rest of the world – there is general uncertainty as to what might happen next.

Futures Daily carried out a poll of almost 7,000 local investors. Around 55% thought the eurozone would support Greece – but said that its rescue would be akin to ‘gradually heating the water to boil a frog’. That is to say, the measures would delay but not resolve the overall problem.

A further 22.5% thought that Greece would be allowed to default, with an immediate and heavy impact on global markets. The remainder described the current market environment as “very complex and difficult to determine”. In truth, some of the smartest investors are also increasingly opting for the latter response these days. Christopher Flowers, founder of private equity firm JC Flowers, told Bloomberg: “The problem is it’s impossible to know how it’s going to turn out.”

In such turbulent conditions, China’s leaders have decided their best course is to position the economy – as the Buddhist maxim advises – in the ‘steady’ category. Indeed this week Li Keqiang – who looks almost certain to replace Wen Jiabao as prime minister next year – made a telling remark about the world financial situation. According to Shanghai Daily he said: “China will contribute to the world by running its own affairs well.”


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