China banking risk too great to ignore
Since 2010, China has been the major reason why emerging markets have trailed behind developed markets.
After the gigantic credit injection in the Chinese economy in 2008 and 2009 to cope with the world credit crisis, its growth started faltering in 2010. The slowdown continues to this day. In the first half of this year, Chinese growth still amounted to 6.8 per cent.
In recent years concerns for the sustainability of high growth in China have exerted substantial pressure on commodity prices.
This has had a negative effect on major commodity exporters, such as Brazil and Russia. In the past 10 years, China had become the biggest trading partner for many emerging countries – and not just commodity exporters.
In addition to the negative impact of lower Chinese growth on China’s trading partners, there is a further complication for the emerging world. Since 2008, aggressive stimulus measures have caused an explosive rise in the level of debt in the Chinese economy.
As a percentage of GDP, Chinese debt has risen by no less than 70 percentage points in the past five years. This sharp rise is unprecedented and is causing a great deal of pressure on the financial system.
Where a large amount of new loans are extended in only a short timeframe, a substantial part of those loans tends not to be paid back. We have seen examples of this in the past. The most recent debt crisis in the emerging world was in Russia in 2008, which was also preceded by a rapid, excessive rise in the debt ratio.
Investors have to take into account the greater risk for the Chinese banking sector as a result of the explosive growth in debt since 2008.
In other words, there is a significant risk that Chinese growth could collapse at any time in the years ahead, due to a credit crisis. This partly explains why emerging markets have been under such pressure in recent years.
Capital flows to the emerging world have gradually dried up in the past two years. This is a result of the great imbalances in many emerging countries and the expectation that the US central bank will taper its money-printing scheme in the coming quarters. It is also a response to the state of China’s economy.
Recently, there have been some positive signs from China indicating that economic growth is recovering slightly. Stabilising growth would be good news for the emerging markets; after all, concerns regarding China had grown considerably in the past few quarters. It would mean emerging markets would be able to make good some of their losses in the near future.
On the other hand, a couple of quarters of slightly better growth will do little to change the outlook for the coming years. The growth slowdown will continue and the risk of a Chinese banking crisis, with major consequences for the entire emerging world, remains too great to ignore.
Maarten-Jan Bakkum is senior emerging markets strategist at ING Investment Management