China’s risks extend beyond trade frictions

News and opinion on finance

Sweatshirt label: Quite apt, given the nervous tension around China and trade deals, as well as other concerns

China’s risks plotted in Euromoney’s quarterly crowd-sourcing survey of economists and other experts revealed marginal improvement in the first quarter, yet risk experts are eyeing developments more cautiously in light of continuing trade frictions.

China already has acute political risks with several very low-scoring indicators, such as corruption and transparency offsetting a higher reading for government stability.

Transparency is a particular problem where official statistics are concerned.

By contrast, scores for most economic indicators have generally held up, reflecting the fact policymakers have managed to stop the economy sinking.

However, can these favourable fortunes be taken for granted, when trade talks could take a turn for the worse if Trump carries through with his pledge to increase tariffs to 25% on the remainder of Chinese imports?

And what happens if a trade deal is reached. Is China suddenly a safe bet or are there are other issues lurking?

Thin end of the wedge

China’s asset safety has become more questionable over time, according to Euromoney data.

Its country risk score has fallen steadily during the past five years, prompting a five-place slide in the global risk rankings to 43rd out of 186 countries.

Contrast that with India, another Bric, which has been steadily improving.

Admittedly, it’s a small drop, which still makes China only a moderate risk, marginally riskier than Italy, one place higher, and slightly safer than Peru, just below.

Plus China is safer than most emerging markets in tier two – the second of five categories of risk into which all 186 countries in Euromoney’s survey are split.

A tier-two borrower is generally low-to-medium on the risk scale commensurate with an A- to AA sovereign rating, and China is rated A+/A1 equivalent by all the main agencies.

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Yet as trade frictions and technology issues fester, China’s outlook has become more uncertain, even if the two sides eventually reach an agreement, as many expect they will, and allowing for the fact China will respond with measures to soften the blow.

Allan von Mehren, senior analyst at survey contributor Danske Bank, says: “We believe China will add more stimulus in the form of subsidies for purchases of cars and home appliances as well as further monetary easing through one or more cuts in the reserve requirement ratio.

“China will also continue to do targeted lending through its liquidity measures to the banks, which is conditioned on loans to the real economy.”

Another survey contributor, Arjen van Dijkhuizen, senior economist at ABN Amro, generally agrees, but also points out there will be indirect effects on business confidence and financial markets, and companies will move manufacturing bases from China.

If the US goes ahead and extends the 25% tariff to all imports from China, that would double the amount of imports incurring the charge to $500 billion.

China’s policymakers would respond with more stimulus measures, so overall this will see real GDP growth of say 6.2% in 2019 – a small reduction from previous forecasts.

ABN Amro and Danske Bank both agree on that.

Economists at Hang Seng Bank, another lender contributing to Euromoney’s survey, note how the government’s work report has focused on stability, by lowering the GDP growth target to a new range of 6% to 6.5% (from a point target of 6.5%), with an unemployment rate of around 5.5% (from previously below that level).

These changes are an admission by authorities they are preparing for a more negative outlook, which will lead to a higher-than-planned fiscal deficit of around 4.5% of GDP, adding to the debt pile.

Recent indicators have only endorsed this gloomier prognosis.

Industrial production growth slowed to 5% year on year in May from 5.4% in April, its slowest since 2002, with manufacturing output slowing from 5.3% to 5%.

Retail sales in April and May – bouncing around due to holiday spending – were lower on average than during the first quarter, while fixed asset-investment figures show a slowdown so far this year compared with year-earlier levels.

Automobile exports are down, and prices are up, with inflation bolstered by cases of African swine fever decimating the pork industry.

Meanwhile, analysts are scurrying to rejig their exchange-rate forecasts as trade tensions put pressure on the renminbi.

It is clear that having exhausted tit-for-tat tariff hikes, Chinese authorities just might decide to use the currency as a weapon against US policymakers, although many experts do not envisage this, as China will wish to avoid large capital outflows.

Even so, the prospect of a weaker currency during the next few months is a clear risk until a trade deal is reached.

Other concerns

China’s problems extend beyond the current trade shock. The technology issue is one thing.

As ABN Amro’s Van Dijkhuizen explains: “Our view has always been that strategic tensions between the US and China – particularly on the technology front – would linger on for years, even in the case of some sort of short-term deal that would mitigate the risk of a further import tariff spiral.”

And then there are the structural shortcomings, including the country’s preparedness – or lack of – for a future demographics shock, as well as labour relations as Chinese workers seek better pay and working conditions.

They are two factors receiving low scores in Euromoney’s survey.

And finally, the elephant in the room: experts have become very concerned by China’s hidden debts.

Not only is this a problem for China, it is a big issue for the world economy, with Chinese financing for infrastructure development not showing up in official statistics.

This comes back to transparency – a risk indicator that just so happens to be the lowest scoring of all China’s economic, political and structural factors.

That creates a problem gauging sovereign bond issues in countries reliant on Chinese borrowing, and for multilateral lenders supporting those countries with financing programmes.

And a lot to consider if investors are to crack the Chinese puzzle.

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