Global economy on the brink as ‘butterfly effect’ of China risks major crisis

Global economy on the brink as ‘butterfly effect’ of China risks major crisis

August 17, 2023

Low growth, high inflation and rising interest rates in the West coupled with fears about a stalling Chinese economy are pushing the global economy to the brink of collapse, an economist has warned.

China is battling a deepening slump with economic growth having slid to 0.8 percent in the three months to June compared with the previous month, down from 2.2 percent over the first quarter and equivalent to a 3.2 percent annual rate, which would be among the Asian giant’s weakest in decades.

Beijing is also trying to reassure uneasy homebuyers and investors about China’s deeply indebted real estate industry after major developer Country Garden failed to make a payment to bondholders and suspended trading of its bonds.

Meanwhile, western countries are grappling with high inflation, low growth and there are fears of further interest rate hikes.

First quarter GDP growth was 0.3 percent in the US, 0.1 percent in the UK, 0.4 percent in Japan and 0.2 percent in France, according to the OECD’s May statistics update.

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Professor Emilios Avgouleas, Chair of International Banking Law and Finance at the University of Edinburgh, told it is all adding up to the beginnings of a major economic crisis.

He said: “We are close to the brink because all the major western economies face serious problems with low growth, high inflation and high interest rates so a possible recession in the West will become much worse with a possible recession in China or the possible collapse of the Chinese economy.

“We should not forget the Chinese economy is a dynamic economy, but it is also a highly leveraged economy.”

Professor Avgouleas added that the problems signal a “butterfly effect” with possible Chinese defaults on debt posing a big risk to the global economy.

China’s economy is suffering partly due to faltering youth employment which has hit real estate developers with fewer buyers entering the property market.

Some warn that unless Beijing gets a grip on the country’s heavily indebted real estate developers it could see a cascade of bankruptcies.

Professor Avgouleas said: “The big question [in Britain] is what is the exposure of Hong Kong banks on the Chinese real estate sector.

“Thankfully, there are only two Hong Kong banks with a serious presence in the UK market: Standard Chartered and HSBC. Thanks to legislation, the subsidiaries of those Hong Kong banks should be ring-fenced from their parent companies which means the impact in UK markets should be very limited and mostly contained. The possibiluty of contagion in UK markets is very limited, but there’s possibility of upheaval in global markets.”

Asked how Britain might be affected by the possible collapse of Country Garden, Professor Sambit Bhattacharyya, Head of Economics at the University of Sussex Business School, told it is too early to call.

He said: “Country Garden’s reported negative equity position is significant. However, it’s liabilities and hard assets are mainly local (i.e., China based).

“Given the size of this real estate giant, it would be reasonable to expect that the Chinese government would intervene in any restructuring process to protect the interest of the creditors.

“Despite the volume of losses, it is unlikely to be significant given the size of China’s overall economy and the Chinese government’s asset position.

“Undoubtedly, Country Garden has liquid asset and liability exposure through equity markets. However, it is unclear at this stage the volume and degree of that exposure.

“Any risk of contagion would be primarily through that channel. Risk for the UK would depend on direct or indirect derivative exposure of the UK top-five banks. It is too early to make a call.”

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Financial markets were rattled when Country Garden missed two payments totaling $22.5million due to buyers of dollar-denominated bonds on August 6. It has a 30-day grace period before it would be declared in default.

A Chinese government spokesperson tried to reassure the public and financial markets, saying conditions are improving and regulators are getting debt under control.

Country Garden, which had been considered one of China’s financially healthiest developers, suspended trading of its bonds on Chinese exchanges on Monday.

It came after a warning last week it might post a loss of as much as 55 billion yuan ($7.5billion) for the first half of 2023.

Real estate accounts for some 20 percent of China’s economy. When spending on steel and copper for construction, furniture and other related purchases is added in, estimates of its share of the economy rises as high as 35 percent.

Country Garden’s possible losses are a sliver of those of Evergrande, which reported in June that it lost $81bn in 2021-22.

But both ran into the same problem: having more assets than debt but being unable to turn slow-selling real estate into cash fast enough to repay lenders.

A weak real estate industry complicates efforts by Chinese leader Xi Jinping’s government to reverse the country’s deepening economic slump after a rebound following the sooner than expected end of anti-coronavirus controls.

Jennifer McKeown of Capital Economics said in a report Country Garden’s impact “seems likely to be limited” but “policymakers should step in to prevent a meltdown in China”.

Professor Avgouleas warned there could be more defaults on international bonds akin to Country Garden’s, meaning “serious shocks” for institutional investors exposed to Chinese bond markets.

He said: “One of the world’s biggest economies is unravelling before our eyes and, given how secretive the Chinese regime is about economic data, it is natural for markets to assume the worst.”

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