China's economic slowdown - something else for Germany to worry about

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By:
Kanika Saigal, Euromoney Skew
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China's economic slowdown will exact a heavy economic toll on global demand. Although Beijing has many weapons it can mobilise, its slowdown comes at an inauspicious time for Germany

While all eyes are on Greece, another global threat looms - China’s economy is slowing down. Economic data for April was disappointing and industrial production grew at a much weaker rate than predicted. Following this, the World Bank has revised its forecast for China’s GDP growth from 8.4% in 2012 to 8.2% and a slew of analysts have duly followed suit. Morgan Stanley, for example, recently changed its 2012 GDP growth outlook from 9% to a more modest 8.5% for China.

China is central to the emerging market growth thesis and, of course, integral to global commodity demand. Against this backdrop, fears are growing South east Asian trading partners Singapore, Indonesia and Malaysia will be hit hard while a fall in commodity prices will inevitably affect Australia, South Africa and Brazil, among others. But here's an under-appreciated monster in the closet: if the slowdown is not contained, Germany will have even more on its plate than just Grexit as high quality exports to China and the rest of Asia will hit the European heavyweight hard.

According to a report by the German Institute for Economic Research, DIW Berlin, China, before fears over a hard landing snowballed, was set to become Germany’s second-largest trade partner after France in 2013, with strengthening co-operation in the automotive sector, mechanical engineering, and the information and communications technology sector, in particular. In the first half of 2011, exports to China increased by 25.2% compared with the first half of 2010, while German exports grew by a total of 14.7%, representing a key driver in Germany’s economic outperformance.

But the recent softening in demand from China has already hit German exports and business confidence, say analysts.

Luckily, however, China still has a lot of fire-power to turn its economy around, even after its-growth-at-all-costs stimulus policies after the Lehman disaster, which sowed the seeds of a credit bubble.  Most China watchers reckon the government has myriad fiscal tools at its disposal to boost demand.

“In the first four months of this year, China ran a Rmb 900 billion fiscal surplus,” says Li Wei, economist at Standard Chartered in Hong Kong. “This is much larger than it was this time last year so Beijing has a lot of room to manoeuvre. The government can lower the surplus and even run a deficit to boost the economy.”

“China will recover, but the recovery will be volatile,” says Wei. “Beijing needs to act now.”

Credit for growth

“It’s important for the Chinese economy that credit growth stabilises and recovers,” explains Viktor Hjort, head of Asia fixed income research at Morgan Stanley.

“But, banks are stretched,” says Hjort. To generate a recovery in credit growth and stimulate the economy, more generally, small and medium sized banks will need policy support and "government has a lot of monetary and administrative ammunition at its disposal,” says Hjort.

Weapons of choice

Reminiscent of 2008, when the Chinese government pumped over Rmb4 trillion into its faltering economy to prevent the economy from cooling, China indicated at a State Council meeting held on 23rd May that fiscal stimulus is on its way. Here's a brief overview:

1. Investing in infrastructure

Analysts at Morgan Stanley in Asia believe that China will embark on more "government led infrastructure investment and SOE-led manufacturing investment projects, before gradually relaxing demand controls in the property market".

2. Cutting rates

According to Morgan Stanley, the People’s Bank of China (PBOC) will cut both lending and deposit benchmark interest rates twice this year by a 25 bp margin.

3. Moderate the pace of CNY appreciation/depreciating the yuan

The Central Bank will suspend the CNY exchange rate appreciation against the USD. Together, points two and three “should help the economy by more than 100 basis points," say analysts at Morgan Stanley.

4. Corporate tax cuts

A recent Nomura report states that “a [cut in corporate tax] is very positive for growth,” and although no details were mentioned at the State Council meeting, “potential policies may include extending VAT taxes to more sectors (service sector in particular), and providing temporary tax cuts for SMEs.”

When it comes to stimulating growth, China has a lot of leverage. With policy measures taking shape, Morgan Stanley argues that China''s GDP growth has troughed and will accelerate in the third and fourth quarter this year. Indeed, analysts there raised their 2013 GDP forecast to 9.0% up from 8.6%. Let’s hope so – for Germany’s sake.