Risk Of Hard Landing Rises As China Begins Monetary Easing

Agustino Fontevecchia
Risk Of Hard Landing Rises As China Begins Monetary Easing

Chinese policymakers have begun to selectively ease macroeconomic policy to support growth, according to Barclays’ analysts.  While full on easing won’t come until 2012, China will face a significant economic slowdown as the export sector feels the impact of a fragile global economy, and residential investment, which makes up 12% of GDP, falls drastically as the People’s Bank of China (PBoC) seeks to control a real estate bubble.

In their attempt to execute a “soft landing,” China’s leaders have engineered a slowdown by tightening policy over the last several quarters.  This was a response to unwanted consequences of prior stimulative policy.

China provides policymakers a clear example of the possible unwanted side effects of unorthodox monetary policy, which Fed Chairman Ben Bernanke has referenced in several speeches.  Barclays’ analysts explain that “extraordinary policies designed to stimulate growth during the past years have generated some unintended consequences, such as an asset bubble, overcapacity and imbalances.”

Those imbalances have been targeted in the recent tightening cycle.  For example, PBoC appears set on forcing property prices to fall by about 20% in 2012.  They have also pushed to lower shadow banking credit and non-bank lending. This has led to a slowdown in China’s economy, with GDP slowing steadily to 9.1% in the third quarter and inflation, as measured by CPI, falling to 5.5% in October.

Another consequence, of major importance, is the consistent fall in total social financing (TSF, a measure of total credit expended beyond just banking credit), which fell from RMB 4.2 trillion ($661 billion) in the first quarter of 2011 to RMB 2 trillion ($315 billion) in the third.

A look at Chinese stocks illustrates the case.  Big names like Dang Dang and Youku reported important third quarter losses recently, while Baidu's stock has struggled to move anywhere in the last six months.  The iShares China ETF is down about 18% so far this year

Most, if not all, of China’s slowdown was government engineered, Barclays suggests, but policymakers are beginning to reverse the cycle.  The global economic slowdown will impact China’s exports, which make up a big part of GDP.  According to Barclays, a recession in the U.S. where output falls by 1% and in the Eurozone where GDP contracts by 3.5% would shave off 4 percentage points from Chinese GDP growth.

Even more worrying for the People’s Bank, a 10% to 30% fall in real estate prices would subtract 0.5% to 1.5% from GDP growth.  Barclays’ analysts explain:

The impact of such price changes would be most directly shown in fixed asset investment (FAI). Residential investment is about 25% of total FAI, while gross capital formation is about half of GDP. This implies that residential investment is about 12% of GDP. Residential FAI is currently growing 31% y/y, faster than the close to 25% pace for overall FAI. Consensus expects residential investment to decelerate sharply next year, given falls in both prices and volumes of property transactions. Based on historical experience, a 10-30% price decline could easily lead to slower residential investment, which would subtract 0.5-1.5pp from GDP growth.

In 2012, Barclays estimates that CPI will fall to 4% and GDP to 8.4%, with the economy cooling significantly in the second half of the year.  That will be the time when policy bias swings fully into the easing camp, and policymakers will probably go all out.  This means cutting reserve requirement ratios, asset purchases (much like QE), lowering bank deposit and lending rates, and adjusting the exchange rate policy to favor exports.

China, unlike the U.S. and most of the so-called developed economies, has a lot of firepower left.  But using it could fuel further asset bubbles and other such unwanted consequences.  China's policymakers face a compelling task, they must avoid a "hard landing" or they could jeopardize the global economy, as much of the world today depends on Chinese demand, particularly for raw materials, to keep going.