In this report we outline the likelihood and the consequences of China’s multi-decade investment boom coming to an abrupt end. With the global economy slowing and the housing market showing increasing signs of fragility, the clock is ticking on China’s stellar growth run.
Although we do not forecast an outright collapse, our forecast of sub-8.0% growth by 2012 puts us more in the hard landing than the soft landing camp. We believe the risks to our forecasts are tilted to the downside, with the probability of an outright recession runningat around 30%.
China’s housing market is exhibiting signs typically seen at the end of a bubble. The next phase of the cycle will likely see prices begin to fall as developers offload inventory. We estimate house prices need to fall by 30% nationwide before price excesses are unwound. Tangible evidence of Chinese malinvestment is starting to surface. After cautioning that the massive build-up of high-speed rail should be regarded as a red flag, the Macau casino boom, dependent upon cheap liquidity, could be the next sign of China’s bubble bursting.
As the repayment capacity of loans extended to local government investment vehicles comes under threat, we continue to expect instability in China’s banking system and a surge in non-performing loans.
In the event of a pronounced correction in investment spending, a slump in exports and potential banking sector instability, we find it highly unlikely that the Chinese consumer will be able to shoulder the burden of growth.
An economic slowdown will raise the likelihood of further protests. The major political risk to the economy comes from the ruling party seizing more economic power in response to perceived threats to its political interests.
While no country would be immune from a Chinese hard landing, we would argue that Australia is most precariously positioned. A Chinese hard landing would push the Australian economy over the edge, likely ushering in a recession and potentially triggering a financial crisis.
Regional asset markets do not appear priced for a sharp slowdown in China. H-financials (Chinese financial companies listed in Hong Kong) are set to underperform, while disinflationary forces will weigh on Australian risk assets and support bonds. Consensus expectations of continued yuan strength are not likely to be met.