For now, it’s business as usual. But how China’s Evergrande problem unfolds in the coming weeks could end up influencing global policymakers’ decision-making next year.
Top Federal Reserve and Bank of England officials this week played down contagion risks, as their central banks indicated an earlier start to monetary tightening than markets were expecting, while Brazil jacked up interest rates another 100 basis points in its battle against inflation.
Yet if the Evergrande crisis and spillover across the Chinese property sector deepens a domestic economic slowdown already underway, China’s record share of global growth will surely make them — and others — pause for thought.
To be clear, any such pause from the Fed or other central banks in response to a potential drag on growth, or a tightening of financial conditions, is an unlikely scenario right now.
But the very small tail risk could get fatter, especially with the delta variant spreading, economic data weakening, and credit growth turning negative globally.
Even though China’s economy has been gradually slowing for years, well before the current tremors, it has still expanded much faster than elsewhere. Global growth is hugely reliant on China.
According to George Saravelos at Deutsche Bank, China was responsible for more than a third of world GDP growth pre-pandemic, a “massive global growth turbocharge” which was double its share of around 17% a decade earlier.
When China’s property market last slumped in 2015, the country’s share of global GDP growth was 29%, according to Deutsche.
The World Bank estimates that China will account for around a quarter of global growth this year, the same as the United States.
Economists at Citi note that China has accounted for around half of all global investment growth over the last decade, exerting a “disproportionate” influence on developed economies like Germany and commodity-dependent economies like Brazil.
In addition to the fact that China is one of the engines of the world economy, the Chinese company’s crisis may lead to a slowdown in the country’s construction sector, directly affecting the demand for the iron ore exported by Brazil — the price of the commodity was already falling in recent weeks and plummeted on the expectation that China may buy less. Today, around two-thirds of the iron ore exported by Brazil goes to China.
According to data from the Foreign Trade Secretariat of the Brazilian Ministry of Economy, in 2021, Brazil sold $20.5 billion in iron ore to China until August this year — this accounts for 11% of total Brazilian exports in the period.
They have a fairly benign outlook for the world economy, but warn: “In the near term, China is capable of generating a significant amount of ‘real’, or economic, contagion globally.”
A global economic squeeze
Evergrande, the world’s largest property developer, is buckling under the weight of a $300 billion debt load, almost all owed to domestic lenders. Its bonds are trading around 30 cents in the dollar and its shares have slumped 75% in recent months.
The government has so far not stepped in to support, rescue, or restructure the company or the wider sector, although that may yet happen. The central bank has injected local money markets with hundreds of billions of yuan of liquidity.
The consensus view is that Beijing will ultimately do what is needed to avoid a disorderly default or wider implosion across a sector which accounts for up to 20% of GDP. But economists are now sketching out what the economic impact of that might look like.
In a worse-case scenario, economists at Barclays reckon a 10% contraction in property investment could knock around two percentage points off Chinese GDP growth, and UBS economists say a sharp property downturn could push year-on-year growth in the fourth quarter below 3%.
Economists at Goldman Sachs go further, warning that a deeper property sector downturn and tighter financial conditions could land a 4.1 percentage point blow to GDP next year, “although this remains more of a left tail risk at this point.”
Any of those scenarios would risk dragging growth below Beijing’s 2022 annual growth target of around 5.5%, and put a squeeze on anticipated global growth of just under 5%.
But these are not base-case outlooks, and policymakers around the world are pressing ahead with their domestic agendas.
Speaking after the Fed took a step closer to unwinding its crisis-levels bond purchases and brought forward prospects for its first rate hike to next year, Chair Jerome Powell said Evergrande’s problems are “very particular” to China.
And Bank of England Deputy Governor Sam Woods said on Thursday he is cautiously optimistic the Evergrande situation won’t go “badly wrong”, but it could well be something to worry about in the future.