How US and European recession risks could play out for China
- Given China’s close trade ties with the US and Europe, weakening demand in those markets will have an obvious impact on the Chinese economy
- Also, China’s financial markets will not be immune to the external volatility induced by US recession fears
Looking at the Organisation for Economic Cooperation and Development’s trade in value added (TiVA) data, which traces one country’s true export exposure to another’s adjusted for supply-chain effects, one can estimate the quantum of impact that several landing scenarios for the US and Europe will have on China. In the case of a soft landing, in which the US and European economies slow down but avoid recession, China’s exports to the two markets will weaken accordingly but also avert an outright contraction. This will see its export contribution to gross domestic product growth fall by half relative to 2021 levels.
In the case of a hard landing, with the two economies slipping into mild recession, China’s exports are likely to contract, shaving 0.3 per cent off gross domestic product in the next 12 months. But if they crash-land into deep recession – like during the global financial crisis – the export shock alone could cost one percentage point of China’s GDP.
It is important to note that the above estimates assume all else being equal. In reality, this is unlikely to be the case. In the face of a severe external shock, the Chinese authorities can hardly be expected to stand idly by. Indeed, movements in China’s “credit impulse” – which measures the change in new financing as a share of GDP and is a proxy for the effectiveness of monetary policy – have historically been in lockstep with the rise and fall of export growth, easing when activity slows and tightening when it is strong.
Fiscal policy has also played a counterbalancing role. Since 2008, all three periods of major fiscal expansion in China have coincided with declining export growth. Conversely, periods of strong external performance have seen the authorities withdrawing stimulus. These patterns suggest Beijing is quite likely to step up policy easing should both its major trading partners slide into recession together.
While these actions may help to slow the rise of the yuan-dollar rate, they are not enough, nor are they intended, to reverse the market trend. As risk aversion continues to climb – driven by concerns over policy overtightening and hard landings – the renminbi may continue to struggle against what seems to be an unstoppable dollar in the near future.
Finally, strong co-movements are seen in the US and Chinese equity markets during US market downturns. In fact, the offshore market – with the MSCI China index as a proxy – has tended to underperform the S&P 500 index during past US recession-induced sell-offs, while the onshore A-share market has fared better. The same pattern is unfolding in the current cycle.
Aidan Yao is senior emerging Asia economist at AXA Investment Managers