State lenders Industrial and Commercial Bank of China, Bank of China and China Construction Bank disclosed recently that they had $12 billion in subprime related investment as of June this year. US data also show that China held $107.5 billion in US mortgage-backed securities in June last year, and the amount would likely be higher now.
Some critics (including some regional media) said, rather irresponsibly in my view, that ChinaÆs foreign reserves would be significantly affected by the subprime debts if the experience of the Chinese state banks were extrapolated. Such extrapolation is nonsense, since there is very small subprime exposure in the rest of the financial system, due to the strict control of Chinese financial institutionsÆ overseas investment under the closed capital account.
Thus, the US subprime mortgage crisis should have little impact on ChinaÆs financial system, due to its closed nature. The bulk of ChinaÆs holding of US mortgage-backed securities is in the AAA category. The resilient stock price performance of the Chinese state banks, which are also listed in overseas exchanges, after their revelation of subprime holdings confirms that the problem was firmly under control and would not post any threat to stability of these firms and ChinaÆs financial system.
However, the crisis will have some impact on ChinaÆs real economy through the export channel. The subprime crisis will inevitably slow global economic growth in the short-term. In particular US growth is expected to grow below its potential 2.5% rate for a while. This slower external growth will cut the demand for Chinese exports and, hence, slow overall GDP growth.
ChinaÆs exports are vulnerable to an US economic slowdown because they are being hit by a triple whammy: First, A slowdown in global demand for Chinese goods, due to a moderation in world economic growth even without the US subprime crisis. The crisis will only slow global demand further. Second, the impact of ChinaÆs self-imposed export restraint measures, like the cut in export tax rebates and the introduction of export tariffs and quotas for some products, will become more evident soon. Last but not least, the appreciation of the renminbi will inevitably hurt competitiveness and profitability of Chinese exports.
As a result, ChinaÆs export boom is likely to moderate in the coming months. Since net exports have been a major contributor to ChinaÆs GDP growth in recent years, an export slowdown will also drag down overall economic growth.
However, there are factors offsetting the negative impact of this export slowdown so that a growth slump in China is not likely. The central government has room for fiscal expansion to boost economic growth, if needed. Beijing has been reducing its fiscal stimulus to the economy since 2002, when falling spending and rising fiscal revenue growth cut the fiscal deficit from 3% of GDP to a surplus of over 0.5% recently. With an improved fiscal balance, Beijing can afford to restore fiscal stimulus by raising spending, especially on the much needed social programmes such as medical, pension, and education initiatives.
Second, domestic consumption growth has been steady, averaging over 10% in recent years. The consumption trend is going to speed up due to the governmentÆs policy of boosting private spending as a GDP growth driver, rising income growth, accelerating urbanisation and improving social security coverage.
Finally, domestic capital spending will likely remain strong, and this will offset some of the negative impact of slowing exports on manufacturing capacity expansion. Fast income growth and urbanisation will create demand for housing and, hence, property investment. The central and western regions of the country will continue to enjoy investment boom under the central governmentÆs policy of equitable income distribution.
The immediate implication from all this is that slowing exports are likely to reduce the need for more policy tightening because the economy is expected to slow under the weight of slower external demand. Meanwhile, massive manufacturing capacity expansion in recent years and slowing exports will combine to increase the risk of more job losses and deflation. These issues will again dominate BeijingÆs economic policy decision-making in the coming year.
On a positive note, the subprime crisis is not expected to derail the worldÆs solid economic fundamentals, as growth momentum outside the US, especially in Asia, is still robust. The subprime crisis is a market problem but not an economic fundamental problem. The worldÆs central banks have shown a common front and great determination in preventing the subprime crisis from damaging still benign economic fundamentals. Hence, the current asset market turmoil could well be an opportunity to buy quality, under-valued assets once the dust has settled.
Chi Lo is director of investment research, Ping An of China Asset Management (Hong Kong) Co Ltd.