A Spectre of Bad Debts Haunt China

Despite the Chinese government’s market engineering over the last few months, there have been further signs that the Chinese economy is undergoing a significant cooling. Analysts now worry that the rate of growth is in the 5.5%-6.0% range, far below the government’s prediction of 7%, whilst Chinese inflation and purchasing power continue to drag. For example, one only has to look at proxy data such as the electricity demand where growth was at just 1.3% in the first half of 2015, the lowest rate in 30 years.

Whilst a growth rate of 5% would be an excellent performance for any developed country, it is much slower than China has achieved in the recent past and would undermine the Chinese government’s grip of the situation. What is increasingly worrying, however, is the impact of China’s slowdown on the global markets.

When the global financial crash occurred in 2008, the Chinese authorities instructed banks to “open their wallets and lend” in an effort to maintain their double digit growth. The banks responded with gusto and between 2009 and 2014, the size of the Chinese banking system grew by more than the entire size of the US banking system. There was a huge unprecedented investment-led boom with a huge increase in infrastructure and industrial capacity. Between 2007 and 2011, China’s economic growth was equivalent to all of the G7 countries growth combined.  As developed world growth slowed after the global financial crisis, emerging market countries (mainly China) accounted for 50% of global growth.

On retrospect, it can be deduced that a large artificial boost to lending inevitably led to some poor lending decisions. The returns on much of the investment have probably been very low. The growth momentum has now slowed and now the spectre of bad debts haunts the banks and bond markets.

A sharp slowdown in Chinese growth will have a major impact on the global economy and, as the largest European investor in China and the largest destination in Europe for China’s outward investment, it is inevitable that the UK will also be affected. London stores and hotels have been gearing up to meet the expected boost to Chinese visitors. In the City of London, Chinese banks and financial firms have been expanding strongly and the UK government has been looking to boost the role of London in the internationalization of the Rembibi. Mainland Chinese buyers have been reported to be significant buyers of London Residential Property.

The news that Jaguar Land Rover sales in China fell 32% in the second quarter is an example of the impact likely to be faced by UK companies exposed to Chinese consumers. If Chinese Banks face a significant worsening of their problem loans, this might reduce their desire for expansion in London.   Chinese investment into the UK, including through the buying up of residential property, could also slow significantly.  This would hit a London property market which is already reeling under the effect of recent changes to Stamp Duty.

While it is difficult to forecast the magnitude of the effect of China’s slowdown on the UK, it could be significant especially if you believe as I do that the slowdown in China is going to be greater than currently anticipated.