Quantifying The Top 10 China Risks
Morgan Stanley's Qing Wang has created a new tracking concept, the China Macro Risk Radar (CMRR), whose sole goal is to provide a framework to asses and monitor risk events of low to moderate probability (high probability events already have their own standing at the firm and are singled out in client calls) and high impact. As part of its inaugural edition, MS has assigned 10 risk events to four different categories on the CMRR - each risk event is assessed according to six aspects, including its description, content, potential impact, likelihood, timeframe, and evolving direction. We present the top 10 items that are of concern to investors in China, and are likely to provide even more ammunition to the ever increasing roster of China bears.
The events can be summarized along the following four verticals:
Risk Category A: Macroeconomic
- Risk Event 1: Massive NPLs
- Risk Event 2: Local Governments Default
- Risk Event 3: Economic Hard Landing
Risk Category B: Policy and Regulatory Changes
- Risk Event 4: Rapid Wage Increase
- Risk Event 5: Introduction of Property Tax
- Risk Event 6: Resource Tax Reform
Risk Category C: Financial Market Shocks
- Risk Event 7: Property Bubble Burst
- Risk Event 8: Commodity Prices Spike
Risk Category D: External Shocks
- Risk Event 9: European Sovereign Debt Crisis Redux
- Risk Event 10: Trade Protectionism
Visually, this is summarized as follows:
Here is the drill down by specific category, starting with what what arguably has the most impact on the future of China: the possibility of the complete blow up of China's banking system via a surge in NPLs.
Next in terms of impact - the rolling defaults of local governments:
Last, and probably least impactful in the macro economic category, is the possibility of a macroeconomic hard landing:
In the "policy and regulatory change" category, the biggest risk is the already visible in various region development of a a rapid wage increase.
Next up, the topic that makes daily headlines in the news, and has a both upward and downward impact on the CSI (depending on how some butterfly flaps its wings any given morning), is the Introduction of a property tax
Resource tax reform, while more likely, will probably have less of an impact.
And now for the one all have been waiting for -the property price bubble bursting. While Morgan Stanley assigns only a 20% probability to this event, we believe it is much higher. We also disagree that its impact on the financial markets would be merely moderate: one can argue that the depression currently ravaging the US is predicated by the US property bubble burst. One can see why the property bubble popping halfway around the world in an economy which is basically a mirror image of the US monetary policy would have just as dire an impact (and would perpetually destroy the concept of decoupling, this putting Jim O'Neill out of a job forever).
The possibility of a commodity price spike, while less remote, will also probably have a smaller impact on financial markets, although hardly as little as MS makes it seem.
As for the two key external shocks that are facing China, the main one, and which we believe has by far the highest likelihood, far higher than the traditionally optimistic Morgan Stanley dares to assign, is the reflaring of the European Sovereign debt crisis, which is only a matter of time.
And last is the one thing that can easily end Chuck Schumer's career, whose push to have China revalue the CNY has led to nothing but disappointment, as the US imports in the last month surged to a multi year high. So much for the whole export-led recovery. What happens next is only up to the idiots in D.C., and the probability of an all out trade war is getting ever bigger.
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