The slowdown in the Chinese economy that would be necessary to stabilise its corporate debt ratio over the medium term would have significant knock-on effects for the global economy, strongest for emerging markets (EMs) with high commodity dependence or close Chinese trade links Fitch Ratings said in a recent report.
The sovereign credit impact would also depend on external and fiscal buffers, as well as the policy response.
The scenario entails a sharp capex slowdown that would reduce GDP growth by around 1 percentage point a year for several years relative to baseline.
“We modelled a controlled path towards corporate debt stabilisation that avoids financial instability and a major shift in China’s exchange rate, but that still entails some loss of confidence in EM assets. Moreover, we estimate that global oil and metals prices would be 5%-10% lower than under our baseline. The chart below shows the estimated GDP impact on major EMs, using Oxford Economics’ global model,” Fitch analysts said.
Net commodity exporters would be affected through a decline in direct exports to China and weaker terms of trade. Accordingly, the model estimates a particularly strong impact on Chile, Fitch said.
That said, Chile has a stronger policy framework and more fiscal space than most other Andean commodity exporters, which could also be exposed.
Government debt burdens increased across all Andean commodity exporters following the commodity-price downturn in 2014-2015, and a Chinese slowdown would renew pressure on public finances. External positions have adjusted in most cases to the previous commodity shock, but could be tested again by another drop in prices.
Direct exposure is lower in Latin America’s other major economies, which are generally less dependent on non-agricultural commodities and Chinese demand. However, Brazil’s iron ore exports would be affected and its weak public finances make it vulnerable to growth shocks, while countries with large external financing needs (notably Argentina) would be sensitive to a shift in investor sentiment against EM assets.
Oil producers in CIS countries have become better positioned to cope with a fall in oil prices after strengthening their policy frameworks in recent years.
The impact of a Chinese investment slowdown on Russia, for example, should be softened by greater exchange-rate flexibility, inflation targeting and a more conservative fiscal stance, and might not be as severe as estimated by the model, which is based on historical relationships, the report said.
Kazakhstan and Azerbaijan have followed similar adjustment paths, although Azerbaijan has lagged and appears more exposed.
By contrast, most oil exporters in the Middle East and Africa have made limited adjustments and remain vulnerable to oil-price movements, even if significant reform efforts are underway, eg in Saudi Arabia, it added.
“Exporters of other energy products and metals, such as Zambia, could also be hurt. China’s role as a source of financing in sub-Saharan Africa has increased considerably over the last 10 years. However, this funding might not dry up under our scenario, given Chinese geopolitical considerations and the small size of these economies,” Fitch said.
According to Fitch, Mongolia, which has made progress under its IMF programme, would probably be the most vulnerable of Asia’s net commodity exporters.
China accounts for all of its coal and iron ore exports, and it would be difficult to divert them to other markets.
A drop in oil prices could create fiscal challenges for Malaysia, particularly following its recent decision to abolish the GST. In Indonesia, commodity-related government revenue would fall, but the fiscal impact would be mitigated by lower implicit fuel subsidies.
The other major Asian economies are net commodity importers, and would therefore benefit from a positive terms-of-trade shock. Most have close trade links to China and would be affected through lower Chinese demand for their exports.
“However, the overall impact could be mitigated to the extent that a large proportion of Asian exports to China are components that are re-exported, and therefore less sensitive to a potential Chinese investment slowdown than commodities,” Fitch said.
Bigger effects on the global economy would result if China’s currency were to depreciate significantly in the slower growth scenario, it added.