Fitch Scenario: Sharp China Slowdown Would Hit Global Growth Hard

A sharp slowdown in China's GDP growth rate to 2.3% during 2016-2018 would disrupt global trade and hinder growth, with significant knock-on effects for emerging markets and global corporates, according to a study by Fitch Ratings. In turn, this would keep short-term interest rates and commodity prices lower for longer. This hypothetical scenario does not reflect Fitch's current expectations for China's growth, but is designed to test credit connections between China and the rest of the world.

'China's rapid rise as a global economic power, and its deepening ties to the rest of the world, have forced global credit investors to weigh carefully the potential impact of a sharp China slowdown,' says Bill Warlick, Senior Director, Macro Credit Research. 'After tracing China's financial and trade links around the world, it's clear that a greater-than-expected deceleration in Chinese economic activity would have far-reaching implications for global growth, corporate credit quality and monetary policy.'

Prolonged Impact on Growth and Rates

This hypothetical Chinese slowdown scenario, framed with the help of Oxford Economics' Global Economic Model, would slow global GDP growth to 1.8% in 2017 from Oxford's August base case of 3.1%. As a result, any rise in U.S. and eurozone short-term interest rates would be postponed, and oil prices would remain under pressure.

'Lower-for-longer in terms of growth, interest rates and commodity prices, could be the defining mantra of this decade for the major advanced economies if a Chinese shock scenario materializes,' added Warlick.

Corporate Impact

A China slowdown scenario would also impair the credit profiles of many companies globally, particularly commodity-dependent ones in oil and gas, steel, and mining. The focus of impact from a sudden slowdown remains generally unchanged from 2010, when Fitch and Oxford conducted a similar study. Shipping companies would also suffer, as commodities account for a significant portion of freight volume. The global technology, heavy manufacturing and automotive sectors would also feel increased credit pressure due to a slowdown in Chinese demand.

'A sharp China slowdown would further impair credit quality for oil & gas and commodities companies already pressured by the current low-price environment,' says Andrew Steel, Managing Director, Asia-Pacific Corporates. 'Knock-on effects like anaemic or slowing global consumer demand and commodity supply gluts would persist or worsen.'

Within Fitch's rated portfolio, 25% of oil & gas companies and 52% of other commodities companies are already sub-investment grade. If the scenario materialized, it could create ripple effects through the high yield bond market.

Geographic Impact

The impact of a China slowdown would be felt most in Emerging Markets, particularly in Asia and Latin America, due to the high concentration of China's largest trade partners in these regions.

'While China's share of imports from within the Asia-Pacific region have fallen slightly since 2009 as its trade and investment ties to other regions increased, the region is still far more closely tied to China's economy than any others,' says Andrew Fennell, Associate Director, Sovereigns.

In particular Korea, Taiwan, Hong Kong, Japan, Singapore and Australia would all face trade-based GDP slowdowns. Hong Kong would experience a contraction of GDP in 2016 of more than 3% lower than Oxford's base case. Japan would also enter a recession in 2016 and 2017.

In Latin America, commodity-related exports represent the vast majority of all regional exports to China, leaving the region highly exposed to a sudden slowdown scenario. Chile is most sensitive to a shock, with GDP potentially deviating by 7% from Oxford's base case under the scenario. Softer commodity prices and Chinese demand would push 2017 growth rates in Chile and Brazil down by 4.5 and 1.6 percentage points, respectively.

The U.S. and Europe rely less heavily on Chinese trade to drive growth, insulating them from a Chinese shock scenario to a greater extent than their emerging market counterparts. Of the Western developed markets, Germany's larger share of exports to China leaves it most exposed. However, at only 2.4% of its GDP, the impact would be relatively limited. In the U.S., a sharp deceleration in Chinese growth resulting in reduced import demand could drive the bilateral trade deficit with China wider.

Fitch's China Slowdown Scenario assesses the impact of a hypothetical slowdown in China's economic growth rate. Using Oxford Economics' Global Economic Model, Fitch focuses on the potential credit implications across a broad range of rated issuers over the three-year forecast period through year-end 2018. The shock scenario assumes average Chinese GDP growth of 2.3% over that period, materially lower than Fitch's 2017 base case of 6.0%.

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