Why China's slowdown could become a regional crisis
Bryan Borzykowski March 14, 2016
The sluggish GDP growth of the world's most populous nation is affecting nearly every other country on the planet.
This article first appeared on ZurichVoice on Forbes.com.
It's hard to go a day without reading or hearing about China's slowdown, and for good reason: The sluggish GDP growth of the world's most populous nation is affecting nearly every other country on the planet. China is a massive consumer of global commodities, so when demand for those resources falls, everyone feels it.
China's GDP growth has slowed from about 10 percent in 2010 to an expected 7 percent this year. Some analysts believe China's growth has stalled even more—Capital Economics reported that the economy grew by just 4.5 percent in the fourth quarter of 2015.
Although a reduction in infrastructure spending and an increase in debt have contributed to the decline, the biggest reason for the slowdown is China's move from an export-driven economy to a domestically focused one, said Jim Thomas, global head of credit and political risk at Zurich Insurance.
The country is trying to transition from an economy based on lower-value-chain manufacturing to a more service- and consumer-driven economy, Thomas said.
No economy as big as China’s has made this transition, making it difficult to predict when—if ever—the country's economy might start producing double-digit growth again.
It doesn't help that many of China's banks are buried under trillions of dollars of debt. After the global recession in 2009, the government—and the banks—spent significant amounts of money on infrastructure projects to keep the economy growing.
Chinese financial institutions also loaned money to other emerging markets to help keep their economics afloat. Now there's an estimated $5 trillion outstanding on their balance sheets.
Impact on Brazil, Australia
China's troubles are taking their toll on commodity prices and the global economy. Oil prices, which have fallen by about 72 percent over the last two years, have dropped, in part, because of falling energy demand in China.
Other commodities—and the countries that produce them—have been affected significantly by the Chinese slowdown. China accounts for about 65 percent of the world's iron ore imports and sources much of the material from Australia and Brazil. According to Chinese customs data, the country gets about 63.7 percent of its iron ore from Australia and 20 percent from Brazil. Over the last five years, the price of the commodity has fallen by about 77 percent and has declined to its lowest point in nearly a decade.
Australia has experienced major layoffs in mining—a survey in mid-2015 found that 80 percent of mining bosses in the country were planning to cut their workforce. However, the price decline has really taken a toll on Brazil, which will see its GDP slow to about 1.1 percent in 2016, down from 7.6 percent in 2010, according to the World Bank.
Brazil actually exported more iron ore to China in 2015 than in 2014, but that export growth is offset by lower prices. “Both of these countries are exporting more, but at lower prices," Thomas said. “In the case of Brazil, they're just trying to keep their economy afloat regardless of the price."
In Malaysia, another big iron ore exporter, production has been cut by 20 metric tons, Thomas said. The World Bank now expects the country's GDP in 2016 will drop slightly to 4.5 percent, compared with last year.
Zambia at risk for default
Copper is another major resource that has seen big price declines due to slowing demand. China accounts for about 45 percent of all copper imports, according to the CME Group, and the slowdown has caused the price to fall by 38 percent over the last two years.
The falling price of copper has put enormous pressure on Zambia's economy—the country is responsible for 70 percent of Africa's copper production, according to Trading Economics. “It may not be a country that's in the news a lot, but it's important in finance and commodity circles," Thomas said. There's now real concern about the Zambian government’s ability to withstand a prolonged slump in copper prices, he added.
A default could have a large impact on U.S. and European banks, Thomas said, as many financial institutions hold Zambian credit. The situation could worsen if there's no visible improvement in China.
What happens next?
Other nations, including Canada, Bolivia and Peru, are feeling some impact from the Chinese slowdown. Although we don't know when, it's likely that China will make moves to stabilize its economy, Thomas said.
Unlike most other countries, China can take unilateral steps, such as injecting billions of dollars into infrastructure spending at a moment's notice or actively managing its exchange rate. “People are underestimating the actual strength of resolve to undertake reforms," Thomas said. “Growth is stalling, but they have more than $3 trillion in reserves and they can undertake very direct measures."
Still, companies that want to invest internationally need to be aware of the impact that China's slowdown may have on business. Commodity-exporting countries could suffer for some time, which could affect local currency movements, government policy and societal stress.
As a result, companies need a “robust risk management strategy," Thomas said. Executives must assess the risks and come up with alternative plans if the situation worsens in a particular foreign market. “It comes down to understanding the impact," Thomas said. “Where China goes, so goes the global economy."