Slowing China: Who Will It Hurt the Most?

Emerging markets will likely suffer the greatest pain from a slowing Chinese economy

Robert Johnson, CFA 26 March, 2012 | 12:52PM
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For those who didn't believe the Chinese government a couple of weeks ago when they reined in their growth prospects (to a mere 7.5%), this past week's news more or less confirmed those warnings. Last week started with news that Australian miners were reporting a weakening of orders from China. Then later in the week the most recent set of purchasing managers' reports out of China showed another small decline. Then, to top off the week, some shippers noted a slowing in demand because of softening international trade and a general move toward cheaper but slower shipping alternatives. FedEx (FDX) even announced that it planned to send a few of its jets to the desert for storage to realign supply and demand.

Interestingly, the biggest exporters to China are Japan, South Korea, and Taiwan. Yet each of these countries is much smaller than the eurozone 27 and the United States. It appears that more emerging-market countries are in the direct line of fire of a slowing China while the developed economies are more likely to take a glancing blow.

On the other side of the equation, China exports most of its goods to large developed markets, especially Europe. The eurozone 27 is by far the biggest market for China's exports, exceeding the United States by a healthy margin. Unfortunately for China, Europe's softness is already turning up in the trade data. Shipments from China to Europe that grew by 11% in the first quarter fell to a negative 3.7% rate in the third quarter of 2011.

Putting it all together, a slowing Europe is a big deal to China because it is China's largest export market, and exports in general are a bigger portion of the Chinese economy. Flowing the other direction, as China slows, the most affected economies are likely to be its East Asian neighbors and commodity suppliers.

Europe and the United States will feel some impact too, but exports to China just aren't a very big number compared with the two largest economies. For some idea of scale, the eurozone exported nearly as many goods to Switzerland in 2010 as it did to China. Driving home the point, Mexico is twice as big an export market for the United States when compared with China. In terms of approximate scale, the eurozone 27 is about a $17 trillion economy, the United States about $15 trillion, and China about $7 trillion, in 2011.

The question now is, can China keep a small slowdown from turning into something more serious?

Europe isn't going to get a lot better in the short run, though a stronger United States may pick up some of that slack. China's internal demand hasn't been spectacular as their booming housing market cooled and the relatively high inflation in 2011 took its toll (though inflation is now down meaningfully from its high). Some of the current economic slowing was engineered by the Chinese government by raising reserve banking requirements and interest rates and by tightening lending. This was all meant to bring down a booming 6%-plus inflation. And for now it's working; both the economy and inflation have slowed. In fact, they are slowly reversing the tightening, making some loans easier to get and reducing the reserve requirement (but not rates). Paradoxically, they are simultaneously raising the price of subsidized refined products, including gasoline, which may weigh on consumer spending. It seems only time will tell how these moves by Chinese policymakers will play out in China and eventually effect the overall global economy.

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Robert Johnson, CFA  is director of economic analysis with Morningstar.