Long-standing worries about China's high leverage, property bubble and excess capacity have been fuelled by recent interbank liquidity squeezes and troubles in the trust market, which have led to renewed fears of a hard landing or even a financial crisis.
Structural issues notwithstanding, we don't expect a hard landing or systematic financial crisis in the near term. GDP is projected to grow by about 7.8 per cent this year, led by improving exports and recovering consumption, which should offset the slowdown in investment, especially in infrastructure. Credit growth may well slow but be sufficiently robust to support economic growth.
However, as the government moves to slow the pace of leveraging as the risk of shadow credit default rises, volatility in interbank liquidity and credit growth is the major risk this year.
But what if a big credit event caused a sharp deleveraging, or there was a grave policy error or big external shock? In such a case, a financial crisis would still be very unlikely, but a big slowdown in growth could occur. How might such an outcome affect the rest of the world and what economies are most at risk?
Given China's importance in the global economy, it is probably safe to say that everyone would be affected. Nevertheless, economies with extensive trade and financial ties with China are most at risk, though others may be affected.
Trade links are pivotal, given that China is the world's largest exporter and third-largest importer. Economies in East and Southeast Asia as well as major commodity exporters are most exposed. They include Mongolia, Hong Kong, Taiwan, Australia, Korea, Japan, Southeast Asia and commodity exporters in Latin America and Africa.
Financial linkages between China and other economies are much less extensive, since Beijing maintains substantial capital controls. In general, the scale of lending to Chinese entities by foreign banks is limited as are overseas activities of Chinese banks. The exceptions are Hong Kong and Singapore, where banks have built up sizable exposure to China's banking and corporate sectors in recent years.
But their exposure is largely in the form of trade financing or interbank lending, rather than direct exposure to Chinese companies or to the onshore construction boom. For Hong Kong, large direct investments by the mainland and the burgeoning offshore renminbi market would also probably be affected in the event of big trouble in China.
Apart from trade, investment and financial linkages, a hard landing in China would probably have a serious impact on global financial markets, especially emerging markets.
However, the scope of the contagion is difficult to predict and has the potential to spread beyond the "usual suspects" - that is, vulnerable countries with twin deficits and high leverage.
In 1997, the Asian financial crisis started with currency devaluations in the Philippines and Thailand, but contagion quickly spread across Southeast Asia and Korea. Economies that supposedly had sound fundamentals before the crisis were also affected. In the following year, the crisis in Russia and later in Brazil also spread to other regional economies and currencies.
This time around, one could argue that the vulnerabilities in most emerging markets, especially Asia, are lower due to more flexible exchange rate regimes, larger foreign exchange reserve buffers and smaller foreign exchange-denominated debt. On the other hand, China is much larger than the crisis economies in the late 1990s and has contributed more significantly to global growth. At the same time, the credit boom in some emerging economies following the global financial crisis, and multiple rounds of quantitative easing by the major central banks, should also be taken into account.
Countries that have experienced significant short-term capital inflows in the past few years are particularly vulnerable. In Asia, these include India, Indonesia and Thailand.
More generally, emerging economies that have experienced a credit boom and, more importantly, have relied on foreign capital flows to finance it are more vulnerable to external shocks and contagion.
These metrics are useful but not entirely reliable as past experience shows that contagion can be unpredictable, especially when investor confidence is shaken. The analysis of trade linkages, investment and banking activity between China and the rest of the world provides some guide to the likely impact of a hard landing in China on global growth, current account deficits, commodity prices, exchange rates and bond yields in other countries.
However, a major problem in China is likely to prompt a widespread loss of confidence in the emerging markets, resulting in a sudden and indiscriminate surge in risk premiums across assets and markets. In such a scenario, even those countries without direct links with China and those with relatively sound economic fundamentals would be vulnerable.
Dr Tao Wang is head of China economic research at UBS