When China sneezes who catches the cold?

Since the early 2000’s, China has grown into one of the world’s two main growth engines, along with the United States. This situation intensified during the global financial crisis and has remained unaltered in recent years. Therefore, any slowdown or economic turmoil in China has dramatic consequences worldwide. The recent lackluster situation in China’s property sector and less robust infrastructure spending at regional levels due to financial constraints have reduced demand for commodities. This situation has exerted further downward pressure on prices and hit growth among commodity-export-driven nations. Developed countries are also feeling the pain of weaker growth in China mainly due to lower purchases of consumer goods, including luxury items. Nevertheless, it is worth highlighting that China is now in a soft patch, which means weaker growth, but not declining economic activity (at least not for now).

The countries most affected by the slowdown in China will be those that have an open economy and are heavily exposed to the world's second-largest economy. Within this context, one of the most affected economies is China’s neighbor Mongolia. The country had been one of the fastest growing economies from 2010 until early this year, but in Q2 Mongolia expanded a meagre 2.2%. This was mainly the result of China’s falling imports of minerals, which plummeted on average in Q2 and Q3 by nearly 30%. Although to a lesser extent, this situation is similar to what happened in Hong Kong, Korea, Malaysia and Taiwan, which all recorded multi-year falls in shipments to China partially due to lower demand from the world’s second-largest economy. To illustrate the impact of the recent slowdown in China on the Asian economies, FocusEconomics panelists cut 2.0 percentage points from Taiwan’s economic outlook and they now expect the island nation’s economy to expand only 1.5% in 2015.

Another spillover of the slowdown in China and, more recently, this summer’s turmoil in the equity market, is that the Chinese are spending less overseas. The consequences of this decline are most evident in Hong Kong, where retail sales have deteriorated markedly in recent months. It’s also fair to add that the nations that are feeling the brunt of China’s weakening economic growth are precisely the ones that benefited the most during the boom years. Conversely, the countries that are weathering the storm from China better are those with a stronger domestic market and which are less reliant on exports. One example is India.

India is in a better position to withstand China’s slowdown than many of its regional peers simply because it isn’t an export powerhouse. India’s economic growth is driven by domestic demand, which is expected to remain resilient in the near future. Consumption, although performing below potential, will be supported by slowing inflation (which has almost halved from 2013 to 2015) and the low commodity price environment should benefit Indian firms and the country’s current account deficit. Moreover, Indian businesses are not highly integrated with the Chinese economy; exports account for a relatively-small portion of GDP and Indian exports to a diverse market with China accounting for around 5%. That being said, a significant slowdown in China would impact India through general capital outflows from emerging markets and a broader global trade slowdown, especially one that ripples throughout Asia.      

The key area for India to address to fuel future growth is implementing meaningful economic reforms. Although Prime Minister Narendra Modi was elected on a campaign chock full of ambitious reforms and a plan to foster foreign investment, the government has yet to deliver on many of its key promises. Easing labor market rigidities, simplifying tax procedures and reforming land acquisition laws are all key changes that would encourage investment and improve the business climate. In addition, improving the country’s infrastructure, which is poor, revitalizing credit growth and addressing the banking sector’s vulnerabilities are all steps that can help support the economy’s momentum.    

In 1990, 12 years after Deng Xiaoping and the Communist Party of China started a gradual but steady reform of the economy, China’s nominal GDP was around 400 billion and the country was struggling to enter in the world’s top ten largest economies. 25 years later, China has become a global economic power with a nominal GDP of nearly USD 11 trillion, while ranking second only to the United States. The emergence of China has had vast consequences for the global economy. In particular, this situation has been enormously positive for China’s neighboring Asian countries, which benefited from the years of economic boom in China and rising demand. Nevertheless, the current slowdown is threatening to destabilize some countries in the region. While it is true that some countries are less exposed to fluctuations in the China’s economy, in general, the region has become extremely dependent to economic developments in the world’s second-largest economy due to an increasing regional integration. Therefore, instead of asking who is catching the cold when China sneezes, now it is more appropriate to say, “who is not going to the hospital when China appears to be sick?”

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Date: November 9, 2015

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