China: coming back down to earth

China: coming back down to earth

If you’ve ever had a go at paragliding, you’ll recognise that feeling of being split between elation as you negotiate headwinds and tailwinds to ride the thermals and trepidation at the thought of when and how you’ll come back down to earth.

Logically, you know that what goes up must eventually come down. But at the same time, you don’t want to break both legs when it happens. Something very similar is happening in the Chinese housing market right now.

Spurred by the recent increase in interbank lending rates (SHIBOR), Chinese authorities are attempting to avoid a hard landing in the economy. They’re doing it by trying to engineer a slowdown in credit growth and house prices, which have been growing at double-digit rates, and clamp down on shadow banking—lending outside the formal banking system. In the past, increases in SHIBOR have led to sharp falls in Chinese property prices, for example, in 2012 and 2014. This has not happened so far in 2017, because things look very different on the supply side this time around.

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Chinese property inventories across the first- and second-tier cities are much lower than in 2012 and 2014 and have stabilised at relatively low levels. The lower level of property inventories mean that the risk of an outright house price crash should be more muted than in the past, while Chinese growth will probably slow in the second half of this year. This lack of significant oversupply in housing should limit the extent of the slowdown, reducing the risk of a housing crash. So despite the rise in SHIBOR this year, there has been no associated change in the benchmark policy rate and reserve ratio requirement for banks. 

But we all know that markets aren’t always logical: psychology matters, and levels of global confidence could well be affected by events in China. China’s economic and financial linkages to the rest of the world have undoubtedly been growing, but they are probably still not large enough for financial problems in China to cause a major downturn in the global economy. On paper, at least, neither foreign banks’ exposure to Chinese debt, nor China’s share of global trade, are at levels that would be likely to derail the global economic recovery in the event of a serious slowdown in Chinese growth.

Global exposure to China is smaller than sometimes perceived: Global investors are not currently focused on the global impact of a slowdown in China , and the direct impact of slower growth in China on the rest of the world could be smaller than many predict. While China’s share of global trade in goods and services has grown, it has only increased by less than four percentage points over the last decade and remains at 10 per cent. In addition, Chinese demand makes up a relatively small share of other countries’ exports, with the US and euro area markedly less exposed than other countries in Asia. 

And foreign ownership of Chinese onshore debt has actually been falling, with only 1.3 per cent held externally. What’s more, foreign banks’ exposure to Chinese debt, though higher than before, is just 2 per cent as a portion of their total assets. There are likely to be some financial linkages that are not fully captured by the official data, including offshore borrowing by Chinese companies. But based on most reasonable estimates, direct foreign financial exposure to China has not yet reached a level where it would directly cause significant trouble for the global economy.