Just as the 2008 global recession was led by a property and stock market crash in the United States, there is growing consensus that China’s deepening financial crises – caused by excessive investment in property, commodities and stocks – will inevitably cause a hard landing in its real economy, sending deflationary ripples across other Asian economies which have deep trade and investment linkages with China. Indeed, some experts suggest the deflationary ripples caused by the slowing Chinese economy are already being felt across other Asian economies. The pain has just begun. There is more pain to come in the next year or two.
“In a sense, a China-induced economic slowdown in Asia is already underway. It is happening and we have to see how long this will last. And India will be affected by China’s overcapacity, which is bound to get exported to all its trading partners in Asia.” says Arvind Virmani, a former Executive Director representing India at the IMF.
Virmani argues the crisis will remain until China’s overcapacity works itself out and a new equilibrium is reached between supply and demand. This might take a few years, though.
So China is the elephant in the room which all economies, especially those in the Asian neighbourhood, need to keep a very close watch on. Indonesian Vice President Jusuf Kalla recently said he was worried about the events in China much more than in Greece. The first big indicator of the deflationary effect from China is that Singapore is now facing negative GDP growth (-4.5%) in the last reported quarter. Singapore, largely dependent on foreign trade and investment flows, is seen as a bellwether economy that tells us about what may be coming.
India is already facing a massive influx of cheap steel from China. Since 2014, April steel imports have risen by an unprecedented 70%, mostly from China. This is happening at a time when the domestic India steel industry has doubled its own production capacity over the past decade. Many steel companies have defaulted on loan repayments to both public and private sector banks in recent months, partly because of this evacuation of Chinese overcapacity at cheaper prices. The Indian steel industry owes about $50 billion in debt to banks and if China continues to slow down at the current rate, there will be mayhem not only in the domestic steel sector but also in banks that have lent huge sums to the sector.
So India is not insulated from the Chinese crisis as some policymakers might like to believe. In fact, when Chinese stock markets crashed by about 30% in recent weeks sending ripples of fear across Asia, India’s leading business paper, the Economic Times, prone to excessive optimism, had a lead story on the front page suggesting that the Chinese market crash is actually good for India! Some analysts took a narrow finance capital view that more foreign portfolio investment could come to India as China becomes a less attractive destination. This is clearly a case of being myopic because China is one elephant whose fall can damage a lot of economies in ways beyond one’s comprehension.
The fact is China today is the single largest contributor (over 35%) to world GDP. If an economy of this size were to have a partial hard landing in the months ahead, which is the consensus view among economists, China’s GDP is bound to slow down to about 5%. China is currently reporting 7% GDP growth quarter after quarter but objective observers believe it is closer to 6%.
The reason why China will have a partial hard landing is because it injected a massive stimulus of $600 billion dollars after the 2008 global financial crises. Indeed, the fiscal and monetary stimulus helped China double its GDP from $5 trillion in 2009 to about $10 trillion today. However, a large part of the stimulus went into the real estate sector as China created massive overcapacity in housing. This resulted in a property market bubble that threatened to burst in 2014. To stave off an imminent bust in the property market, China eased its monetary policy further and government banks gave easy credit to support property prices. But a lot of this money got diverted into the stock market, sending the Shanghai index soaring by about 150%. Then came the big stock market crash in early June this year. China has taken unprecedented measures to support its stock markets. Government-run banks have been prevented from selling shares. Brokerage houses got massive liquidity support from the Chinese central bank in order to keep the stock markets steady. In short, massive capital controls have been imposed.
But there is no knowing whether the markets believe that fundamental stability would return with just government efforts. The Chinese authorities do realize that the excess stimuli delivered after the 2008 global financial crisis has indeed created asset bubbles, whether in property, stocks or commodities, which need to work themselves out. Another stimulus of the same order as in 2008-09 is out of the question. So a semi-hard landing is inevitable in China. In 2009, China’s total debt – including those of the government, business and household – was about 130% of GDP. After the big stimuli packages of the past six years, this stands at roughly 270% of GDP. It is self evident that this cannot be repeated again. So some sort of partial hard landing will have to be managed, and other Asian economies will have to brace for its ripple effects.
I have not seen any articulation of this fast approaching crisis from either the Prime Minister or the Finance Minister. Arvind Virmani says substantial parts of the Indian economy which are globally linked – in terms of being part of global trade and pricing regime -will be negatively impacted until the Chinese overcapacity plays itself out. However, Virmani holds out hope for those parts of the Indian economy which may not get affected by the severe Chinese, and consequently Asian, slowdown. The NDA government can dramatically scale up its activity in roads, railways and other transport infrastructure – largely public sector funded – to somewhat neutralize the negative impact of a China-induced recession in Asia. Otherwise India cannot grow at 8% when most other developing economies are either in recession or in a severe slowdown. The Modi government needs to articulate a clear strategy in the context of what is happening in China. So far, we have heard nothing.