Grab the Bull by the Horns

I got my hands on a Morgan Stanley economic research report on the Chinese economy yesterday…conclusion: China’s bull run is far from over.

The report focused on the types of economic shocks China was likely to face (not the likelihood that they would happen) and analyzed the economy’s current ability to absorb such shocks and limit the fallout. Three possible shocks were identified:

1) A substantial weakening in external demand

The report notes that exports have been the primary driver of Chinese growth (exports now account for 40% of Chinese GDP). If there is a substantial drop in demand for Chinese exports, China will see deflation as it did during the East Asian financial crisis and after the NASDAQ bubble burst.

However, the report notes that the government is in a good position to counter this problem because Government is very low for a developing country (18% of GDP vs. an average around 50% for most developing countries) and thus could dramatically increase fiscal spending over the short term to combat the problem.

2) Banking sector instability in the aftermath of a Shanghai stock market bubble burst

The report notes that if the banking sector has substantial exposure to the stock market in the form of direct or indirect loan exposure, a figure that can’t currently be calculated accurately, a shock would be possible from non-performing loans.

However, currently bank balance sheets indicate that the large banks would currently be able to absorb much of the bad loans before feeling a credit crunch. Furthermore, the government’s low debt level would allow it to bail out banks in the case of an emergency; according to Morgan Stanley statistics, if the banking sector had 30% of loans become NPLs in the aftermath of a crash and the government bailed them out, government debt would only rise from 18% of GDP to 23%.

3) Bad policy choices

Obviously bad economic or political choices could trigger recession or even economic shocks. But the report concludes that such a change is unlikely because China has demonstrated dramatically improving command of macroeconomic policy and exercises much less control over the economy than it used to.

The Olympics

As a final caveat, the report downplays the significance of the Olympics on the Chinese economy. It notes that economic downturns in the aftermath of an Olympics happen in cities that represent the majority of a country’s economy and population (Seoul, Athens, etc). Los Angeles, Atlanta and Sydney did not cause macroeconomic downturn because the investment in the Olympics did not have a large influence on the economy of the country as a whole. Beijing represents 1% of China’s population and 3% of its GDP. Therefore, even a massive downturn in Beijing will only have a marginal effect on China’s overall economy (good unless you live in Beijing of course).

Overall, I think that the optimistic tone of the report is probably correct. But it is very limited in its scope. While a stock market crash might not threaten the system as a whole, it could cause millions of residents to lose their life savings. And while the Olympics might not have a large direct effect on the country’s economy, Beijing itself is certainly at risk of a bubble burst. What would the psychological effect of a large recession in the city’s capital be on the country as a whole?

While there are certainly many legitimate economic challenges on the Chinese horizon, the future is still looking pretty bright.

No comments yet... Be the first to leave a reply!