China slowdown worries still uppermost

A sudden slowdown in the world’s second-largest economy would send jitters across the globe, not least in Indonesia and Australia.

A sharp slowdown in the Chinese economy was the biggest concern among financial experts polled at a Fitch Ratings conference in Hong Kong on Tuesday, as they fretted about the wider repercussions, not least in Indonesia and Australia.

Of the 90 delegates present at Fitch's Global Banking Conference, 43% cited a sharp Chinese economic slowdown as the biggest risk to Asian bank credit, followed by high levels of domestic indebtedness with 25%, Federal Reserve policy tapering on 22% and domestic politics with 10%.

Although a rapid deceleration of Chinese growth is not a base-case scenario for many analysts, the risk cannot be entirely ruled out in light of the mainland’s shaky property sector, which accounts for 15% of the country’s annual economic output.

“The risk is that real estate construction seems to exceed consumption and could cause [the] broader hard-landing scenario that we seem to [have been] talking about for many years now,” said Andrew Colquhoun, head of Asia-Pacific sovereigns at Fitch, during a panel debate.

“The contagion would first impact the natural resource sector, which has been supplying to China’s construction boom, and that’s Indonesia and Australia,” he added.

Signs of that adverse spillover have already emerged. The residential property sector in China accounts for about a quarter of the country's steel consumption. And now that this has slowed, the price of iron ore, one of Australia's most valuable commodities, has been sent tumbling, losing 23.3% so far this year.

Meanwhile, Indonesian non-oil and gas exports to China — the country's biggest trade partner — declined by almost 13% to $1.59 billion in February from $1.82 million in January, according to the Central Statistics Agency (BPS).

Delegates polled at the conference about the specific risks within China indicated that they were most concerned about a potential collapse of the property market (36%), followed by a failure to make progress on structural reforms (27%), non-performing loans and shadow banking risks (20%), and growing wealth gap and related social tensions (16%).

After another strong performance in 2013, China’s real estate market has showed signs of softening in recent months. Sales have slowed and banks have become increasingly cautious about lending to developers and home-buyers.

Total land sales fell to 1,767 transactions in May in 300 Chinese cities, down 45% from a year ago and 19% lower than in the previous month, according to a survey published last Friday on China’s leading real estate website

In the same month, the total transaction value for land sales dropped 38% year-on-year, marking a 30% drop from April, to Rmb13.75 billion ($2.2 billion).

China’s firepower

Despite these concerns, panelists said they remained confident that the Chinese government still has the policy tools to curb a sharp economic slowdown, including the renminbi exchange rate and domestic interest rates.

Signs that mainland China is looking to artificially control its local currency re-emerged again earlier this year. The renminbi — also known as the yuan — has weakened more than 3% to Rmb6.22 against US dollar since January, a small amount for most emerging market currencies, perhaps, but a dramatic shift for the Chinese currency following years of slow and steady appreciation.

That is the strongest depreciation for the renminbi since Beijing unpegged the currency from the US dollar in 2005 and allowed it to gradually appreciate by around 30% in total.

While tampering with exchange rates is always an option, it’s less than ideal, said panelists, who viewed interest rate adjustments more favourably.

“We think that the monetary policy or interest rate outlook is more important especially when China is trying to transition from a manufacturing-based economy to a more consumer-driven market,” Sean Chang, head of Asian debt investment at Baring Asset Management, said.

“Essentially, minor adjustments in the interest rate will affect the consumer and the aggregate demand,” Chang said, noting how mainland China's retail sector currently makes up around 12% of the country's GDP.

The People’s Bank of China announced on Monday that the targeted reserve requirement ratio — deposits that banks have to keep with the Chinese central bank — would be cut by 50 basis points, effective from June 16. The targeted reduction covers two-thirds of city commercial banks, 80% rural commercial banks and 90% of rural cooperative banks.

Banks' reserve requirements are neither uniform nor transparent in China. Smaller banks tend to have lower RRRs than major banks, which had an RRR of 20% in 2012.

Bank of America Merrill Lynch nonetheless believes that about Rmb50 billion will be released into the interbank system, reinforcing Premier Li Keqiang’s determination to meet an annual economic growth target of around 7.5%.

For now, the risk of a Chinese economic hard landing would still appear to be a remote one. 

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