Downside risks on the rise – Scenarios for Chinese growth

• Financial stress is on the rise turning focus yet again on whether China is heading for a deeper financial and economic crisis.
• While we do see a rising risk of this happening (25% probability), our baseline scenario remains that China has the tools to avert such an outcome and will use them to the extend needed. Yet, due to the recent weak data and rise in financial stress we have revised down our forecast to 4.8% growth this year and 4.2% in 2024.
• We have lifted our forecast for both USD/CNH and EUR/CNH taking the new weaker growth outlook as well as rising risks into account. We now project USD/CNH to hit 7.60 in 12M up from 7.40 previously.

Headwinds on the rise again – Lower GDP growth

As we wrote about in China holiday wrap-up – part three: risks of a financial crisis resurface, 14 August, financial stress has increased lately with another major developer, Country Garden, at brink of default and contagion to the shadow banking system increasingly visible. On top of this economic data has disappointed across the board with both consumer spending, home sales and exports undershooting expectations. Taking these developments into account we revise down growth to 4.8% this and 4.2% next year.

In this baseline scenario we assume policy makers to step up stimulus as broadly

signalled following the Politburo meeting in late July and to take more measures to improve financing channels for developers, lift home sales. We also expect them to provide the necessary lifelines to local governments and facilitate a restructuring of major shadow banking entities in distress, such as Zhongzi Enterprise Group. Our assumption is that they will still strive to reach the 5% target and do what is necessary to at least put a floor under growth so it does not fall below 4-4½%.

So which tools does the Chinese government have at its disposal to fight this crisis?

First, it can follow through on the “forceful stimulus” it already vowed to do in late July in order to lift demand for private consumption, housing and infrastructure investments, see China holiday wrap-up – part 2: Stimulus and private sector plan lift Chinese markets, 28 July. Second, it can increase funding channels for developers. On Friday, PBOC and financial regulators met with bank executives telling them to direct more lending to support an economic recovery. It suggests policy makers are increasingly concerned about the recent financial stress and as the big lenders are state-owned they have some control over the amount of lending. Third, they can cut Reserve Requirement Ratios (RRR) for banks to free up more liquidity to buy credit bonds and increase lending. The RRR for small and medium sized banks is 7.75% while it is 10.75% for large banks. Fourth, like in developed economies China could opt for quantitative easing (QE) with PBOC buying bonds directly in the market. This would serve as a strong signal that they step in as lender of last resort. Why are they not doing it yet? Probably because the other tools have not been exhausted yet and they would rather cut RRR and let state banks do the buying. 

Download the full report!