UP until the 1980s, China hardly featured in trade with the G7. The country taking the largest proportion of its goods in the first half of that decade was Japan, thanks to its geographical proximity, with the remaining G7 nations each accounting for less than 1%.
That changed from the mid-1980s, as the US moved to 20%, according to recent figures. The UK was later to the party, with Chinese import penetration rising from just 0.5% in 1990 to 9%. It is no wonder that, on purchasing power parity terms, the IMF expects China to be worth close to a fifth of global output by the end of this decade.
China achieved its rise by focusing on trade and investment, at the expense of spending. But that is changing, and the transition to a more balanced economy has been responsible for the slowing in China’s growth rate. The government expects growth of 7% this year; other forecasters are less bullish and some believe reported growth overstates the true rate. Deutsche Bank’s (DB) economist for China is expecting a ‘mini hard landing’ – growth falling to below 7% in the first half of this year. To compare, growth averaged about 10% per year in the decade to 2010.
One reason for our view is that policy easing has not happened as quickly as we might have expected. Moreover, fiscal policy is not picking up the slack (China is in the midst of a fiscal contraction) and the property market is suffering.
How could this affect other G7 economies, and the UK? The Bank of England recently announced the assumptions for its 2015 stress-testing of the UK’s financial sector. China will play an important role: the Bank will test resilience to a one-third fall in Chinese property prices, a slowing in growth to sub-2%, and a 10% depreciation in the renminbi versus USD. Such a severe weakening is unlikely – the Bank says its approach is “to explore events that have not happened in recent history, but may nevertheless be judged to be in the distribution of possible macroeconomic outcomes”.
What about more reasonable expectations of moderation of growth, inflation sub-2%, and the property downturn being mitigated by monetary policy easing/recent government measures to cut the downpayment ratio for residential purchases? Clearly, the impact would be less pernicious.
While China has become a far more important trading nation for the UK over the past 20 years, it remains most significant on the export side when it comes to goods trade. Indeed, China is the UK’s sixth-largest export market but the second-largest import source. So the impact on the UK of a slowing in China might be felt more on inflation than on GDP. This could influence UK inflation directly as weaker growth reduces Chinese export prices or leads to a further depreciation in the currency, or indirectly through the impact of China’s slowdown on commodity prices. This would have a knock-on effect on monetary policy.
We should be wary about playing down the impact, however. The UK’s exports to China have risen significantly. So while the impact of slower Chinese growth may not be huge, it will be felt. A weaker China could also have a larger effect on the growth outlook of the UK’s immediate neighbours, and thus on the UK itself. Germany exports far more to China, and Germany is the UK’s second-largest export market.
Rebalancing may be a cause of the slowdown, but every cloud has a silver lining: increasing consumer spending in China could be beneficial for exports. And don’t forget services: as China develops and spends more of its income, it will become a larger consumer of financial services.
A slowdown in what is now, on some metrics, the world’s largest economy could be a mixed blessing. Much will depend on how permanent it proves to be. Indeed, the IMF’s latest forecasts put Chinese growth in five years lower than India’s. But both are set to grow far quicker than the UK’s traditional trading partners – so the UK must look eastwards to secure its future growth. ?
George Buckley is UK chief economist at Deutsche Bank