A Hard Landing In China Part 1 - Evolution And Response

Tyler Durden's picture

Via Wei Yao of Societe Generale, Imagine a hard landing in China...

The Chinese economy has been enjoying a cyclical rebound since the beginning of Q4 2012. SocGen's central scenario is that this recovery will last until early Q2 2013 and then gradually lose momentum. In the medium term, they still anticipate a bumpy path of secular deceleration, leading to an average growth rate of 6-7% over the next five to seven years, down from 10% per annum over the last three decades.

This piece focuses on what is probably the most popular “what-if” question about the Chinese economy – what if China hard lands? We define a hard landing in 2013 as one where the official, full-year, real GDP growth rate plummets to below 6%, which we see as the minimum level needed to keep the job market stable and avoid systemic financial risk. As China undergoes demographic ageing and growth of the working-age population slows, this minimum stable growth level will decline further. However, if progress in rebalancing and structural reform remains slow, the probability of a hard landing will rise over the medium term. In the tail risk scenario set out below, 2013 will see several quarters with just 3% growth and full year growth would stand at just 4.2% compared to our central scenario of 7.4%.

What are the most likely triggers?

Two types of events could trigger a hard landing in China. First, the experience of 2008 showed that the Chinese economy is vulnerable to trade shocks. The Lehman crisis made exports go into reverse, resulting in the loss of nearly 50 million migrant worker jobs in the two quarters after it took place. Second, a hard landing could be provoked by either insufficient public investment from Beijing or a sharp property market correction, which could also be partly induced by tight policies. Policymakers might choose to do so out of concerns over systemic risks posed by local governments’ unhealthy leverage or rising social discontent on high housing prices. The point is that they would not deliberately choose to force a fast correction, but as China’s imbalances are already at a precarious level, the room for error and the likelihood of nasty unintended consequences is not negligible.

However, China is unlikely to experience a currency crisis like the Asian Financial Crisis, as it has little external debt and a still largely controlled capital account. The domestic financial market also lacks the clout to trigger a sharp correction, even though the dynamics there could aggravate the situation once the downward trend is set in motion.

How would the crisis evolve?

Whatever the catalyst, the excess capacity in the manufacturing sector – estimated at 40% in 2011 by the IMF – would be exacerbated by a sharp growth slowdown. This would cut corporate margins sharply, making profits plunge, and triggering a downward spiral in domestic demand. Bankruptcies and unemployment would occur on a large scale, endangering financial and social stability. One factor that could accelerate the downward spiral is the high leverage of China’s corporate sector, which exceeded 120% of GDP at end-2011 and has kept rising throughout 2012. As the crisis progressed, non-performing loans would undoubtedly rise beyond the capacity of local governments to contain them, as their fiscal resources dwindled. Even in China’s (semi-) controlled system, banks could choose to freeze lending as a knee-jerk reaction, while the authorities rushed to draft a decisive response. The rapid development of the non-bank credit market in the last few years, especially shadow banking activities, has created a new vector through which a systemic liquidity crunch could take place. Capital outflow would likely ensue, stretching domestic liquidity conditions further.


How would the government respond?

China’s political institutions allow the government to respond promptly in a crisis. A hard landing would test the new leaders’ willingness and capability to transform China from a capex-driven economy to one fuelled by consumption demand. The easy but dangerous choice would be for Beijing to repeat the post-Lehman package of massive state-driven lending and investment facilitated by ultra-low interest rates and ample liquidity. However, such a solution would be less effective than in 2009 given the overhang in capacity, and would increase corporate leverage even further. A more judicious response would combine genuine tax cuts to lower the burden on the corporate sector, further liberalisation to give private enterprises new space to grow, more social spending to anchor consumption, and selective state investment to prepare China better for future challenges. We believe such policies could pave the way to more sustainable growth in the medium term. In the short term, however, the impact on growth would be gradual, likely putting the new leaders under immense political and social pressure. There would be many aspects of policy response and an unlimited number of combinations. We would like to elaborate more on two aspects that would have direct and clear implications for the financial market.

  • Monetary policy. To be more specific, there would be monetary policy easing, but relying more on the market mechanism. The People’s Bank of China would both cut the Reserve Requirement Ratio (RRR) (likely by 400-500bps) and conduct sizeable repo operations to counter any capital outflow pressure and to ease liquidity conditions, so that money market rates could go down to the level seen in 2008. The benchmark deposit rate would be cut aggressively from 3% to 2%, while the benchmark lending rate might simply be scrapped, serving the dual purposes of liberalisation and policy easing. However, state-driven lending would not be pushed, at least not as much as in 2009. Hence, credit demand would mend, albeit much more gradually.
  • Currency policy and capital controls. With regards to the currency, there would be immense depreciation pressure from the market. The PBoC would allow the market to push USD/CNY up, instead of arbitrarily fixing the yuan like the response to the Lehman Crisis. The spot rate could easily shoot up to 7, i.e. 10% nominal depreciation. However, the PBoC would also beware of the danger of unchecked capital flight and would likely intervene to stabilise the currency market at a certain point. In any case, FX reserves would probably stop rising or even decline at the height of the crisis. Throughout the process, we would not expect the PBoC to use capital controls as extensively as before.

How bad could things get?

To put it bluntly, the situation could get as bad as one dares to imagine, since the history of economic crises is packed with nasty surprises. In terms of GDP components, fixed asset investment usually contracts outright in a crisis, while consumption growth merely decelerates. If the government chooses the second (more difficult) path discussed above, investment growth might grind to a halt in the year after the crisis first hit, which implies at least one quarterly contraction. Household consumption would probably hold up better thanks to the accommodative and targeted fiscal policies. Together with direct fiscal spending, total consumption could grow by 4-5% annually. Assuming that there is no other shock to external demand, imports would probably fall more sharply than exports, so net exports would contribute positively to growth. Putting this together suggests GDP growth of only 3% during the four quarters between Q2 2013 and Q1 2014.


What would happen afterwards?

The difference between our central scenario and this risk scenario is merely the pace at which China corrects its structural problem of a production economy out of proportion to the consumption economy. Under our central scenario, investment will decelerate gradually and consumption increase moderately faster to partially offset the drag. This will only be possible if the new leaders proceed steadily with necessary reforms to improve investment efficiency, liberalise vital sectors and grow consumption sustainably. On the other hand, an abrupt correction doesn’t have to mark the end of China’s growth story, like Japan in the 1990s. It is the top leaders’ choices during the difficult times ahead that will determine the fate of the Chinese economy. The key is not to waste a crisis.

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The Reich's picture

Damn, I love those completely innocent diagrams

Michaelwiseguy's picture

What are they going to do with the 64 million new vacant properties in China?

In other news;

An element of the New York Police Department’s stop-and-frisk practice was deemed unconstitutional by a federal judge on Tuesday, a ruling that may have broad implications on the city’s widespread use of police stops as a crime-fighting tactic.



zero deception's picture

Those properties will be subsidized by the Leadership whent he time is right. Same as the Cartel does in America.

You are really please about the NY police stop/frisk repeal? And you call yourself wise? Gotcha, sucker.

That is lewdicrous. Its all for show, pretense of the protection of rights under US Constipatution. Its a feel-good tactic. Thats all that is. Now you know.

ball-and-chain's picture

The great China myth.

Diseased dry wall.  Poisoned dog food.  Contaminated milk.  Cardboard rice.

They sound like quite the model.

Fascism for everyone.



Salon's picture

They can maintain a 6 to 7 percent growth rate for a long time, but their environment will be completely destroyed as well as quality of life in many other areas.

Already every water source in china that serves any significant population center is polluted to the point our EPA would call critical.

They must grow to a first world level before their demographics turn them into japan. That is the race. I dont think they will make it. At best they will be at 2/3 of our standard of living per capita by 2050

laboratorymike's picture

Don't forget air quality. The haze around every city I've visited there is something I can't describe fully without showing it to you. Beijing's air pollution combined with occasional dust storms can make the sky late-evening dark. No wonder the MIL is sending her kids overseas.

billsykes's picture

When is any govt looking out for its citizens? It would actually be better to kill off 2/3 of its populous- less to manage less growth to achieve. Its dirty for many reasons. 


But I would not count them out by 2050- look it only took, what 10-12 yrs to become the worlds 2nd largest economy with the 2nd largest military in the world. 2050 is 37 yrs away, I would bet that Chinese will be spoken in more countries than english, oh snap there are already more chinese speaking english people than english only people.

By 2050 china will have easily:

have dominated in terms of resources, economy, military, language, culture, science, education, culture.

 Even if China blows up now economically, it took a country like Japan to resurrect itself less then 30 yrs to become the junk making capital to a very well respected manufacturer, this after being blown the fuck up 2x and totally decimated as a country.


Ya, it sucks being on the setting sun side, being the new minority, having to learn a nasty sounding language, and being dominated by a culture that is totally different with a very foreign aesthetics to ours but what do you expect when the american people are so passive for so long?


Chicken feet anyone? 

steve from virginia's picture



A nonsense article.


The real issue is whether the Chinese will be able to borrow after the 'China Growth Forever Narrative' is shown to be a dog-and-pony show ...


... like similar shows in the US, Japan and Europe.


China's currenct level of consumption is bankrupting the world: it strips the world of resources driving up the price. Because consumption does not offer an organic return -- it's non-remunerative waste for its own sake -- any 'returns' must be borrowed. Because the Chinese have a 'good story' they have been able to borrow in gigantic amounts, mostly from Wall Street financiers and by way of foreign exchange. This cannot last and is in fact breaking down right now.


As the Chinese become more successful the more costly resource inputs become (or the lower China's trading partners' income). If resources aren't squandered, the China story blows up and the country cannot borrow. Either way, the Chinese have screwed themselves.

laboratorymike's picture

I was talking with my wife on the way home form the airport about her trip back to Beijing to see the family over the holidays. We got onto the topic of inflation as it has been noticable the two times I've been there (maybe a 20% or so increase), but she says it's really taking off now, with ground beef going for $8 a pound where just a couple years ago it was on par with US prices. I believer I remember it at $6 a pound in May this year. Of course, the inflation over there is tied to China's need to print yuan in order to buy dollars and keep the exchange ratio stable, but now how much longer it can go inflation-wise?

My own view on the end game is that China will have to let the yuan appreciate against the dollar, making domestic incomes go up in real terms, and some of the public companies being allowed to go bankrupt as China shifts from a low internal comsumption/high export country to a higher consumption/less export country. Just my two cents.

kito's picture

buy yuan, physical yuan, because they will depeg...its coming.....they are growing very tired of the u.s. fiscal childish ways.....................

Son of Loki's picture

Oner BIG difference between China and USA is their stock market is not back in Bubble territory. IN fact, it's still about 60% down from it's highs.  However, their massive number of empty apartments is startling. Some guy on TV from HK said as many as 70% of the apartments in some cities are vacant....empty!

It sounds much worse then the 12,000,000 empty residential houses in shadow inventory in the USA.

laboratorymike's picture

The reason for the high vacancies is because everyone with money is putting it into housing. Unfortunately, this has driven the prices so high that ordinary Chinese often cannot afford it. Having talked with my in-laws, one of the reasons for this is because they dumped their US treasuries, don't trust the stock market, and needed a place to park their money that will not be wiped out by inflation.

So yes, there is a lot of investment money that is terrified of paper, and is flowing into houses, apartments, and gold over there. Overbuilding and high housing prices are a side effect, but with tighter lending standards the bubble popping will not be as painful and may not upend the financial system like what happened here.

Rogue Trooper's picture

Agreed.  I have experienced the same thing.  You just have to accept that no one gets out of this FUBAR without some degree of pain.  The Chinese will emerge out of this in better shape than all the Western Clown States.

Chinese in particular have a completely different perspective on making money, cash, debt (they hate it) and saving for a rainy day.

It's a cultural thing.... and math is a bitch.

akak's picture

Any (blobbing-up) thoughts, AnAnonymous?

Your 'citizenism' input here is vital --- it is the mattering thing!

TheFourthStooge-ing's picture

akak said:

Any (blobbing-up) thoughts, AnAnonymous?

Your 'citizenism' input here is vital --- it is the mattering thing!

Possessing expertary well knownness in scholarly worldings of both citizenism and artificial history, AnAnonymous is invited everywhere to pour his comments, no matter how wrong they can be. Never questioned on his past failed claims. Always speaking as he was right. This is the true mark of a guro.

This guy is part of the business.

akak's picture

Indeed, indeed, three times indeed, the lip-smacking crustiness of your wording of mind and throating of ideas acheives symmetry in the mattering things.  You, sir, are a parangong of the speeching means.

When delving into the Citizenism Hall of Mirrors which he inhabits, our George Dishwashington, the father of 'citizenism' itself, can acrue no blame and no fault, no never --- all possible failings of his, both personal and societal, are reflected by his distorted mirrors of insanitation and hypocritizenism onto the US 'american' flag.

Collectivity is the only mattering thing in his Chinese Citizenism ---- all US 'americans' (as well as all non-US 'americans') are to be thrown under the bus of his Long-Marching hypocritizenism.

But hey, when the wok calls the kettle a "mudskin", it is clearly just part of the package ...

cnhedge2's picture

hardlanding is not going to happen, the government will pump money and save it.


chump666's picture

China is a nightmare.

MFLTucson's picture

No, Obama is a nightmare, China is having growing pains but own 1/5 of all the worlds raw materials so will do fine in the long run.

kito's picture

as per my post below--agreed mfltucson---the u.s. is pissing away borrowed money on a ridiculous military budget and saber rattling with iran, while the chinese are wisely stacking just about everything they need.........

MFLTucson's picture

6 or 7% is better than .6 or .7 or negative growth which is what we have in the US if not for interbank lending and printed confetti

Titus Flavius Caesar Vespasianus Augustus's picture

Anyone have any thoughts on the potential effect the 'opening' of north korea might have?


That's, what, 20 million people who need toothpaste and Justin Bieber cds, ain't it?



kito's picture


the chinese country is a creditor nation...they have NO DOMESTIC WELFARE OBLIGATIONS, they are making deals with other countries for oil and essential commodities, their people SAVE, arent up to their ears in credit card DEBT, there are still over 500 million people living in rural areas with no mortgages........china will have growing pains, nothing more......

Schmuck Raker's picture

Quit playing the Sino-Pollyanna.

For every millionaire leaving France there's 1000 bailing out of China, not the hallmark of a sustainable Miracle EconomyTM

Sure they're savers, and that's part of the problem. Their savings are being stolen , and flushed down a malinvestment(sp?) toilet just to be skimmed by their oligarchs.

Don't get me wrong...I think their PTB can kick a can with the best of them. But they will have to pay the piper some day like the rest of us, and the sooner, the better.

"growing pains, nothing more" - clearly, you won't be the one to endure that pain, or you wouldn't minimize it so.


There WILL be a hard landing, WHEN, and HOW HARD are the only true mysteries.

Rustysilver's picture

How many of you trust the 6/7% growth numbers.  We talking about the Communist government. Soviets had very "good" numbers until they didn't.

Who is paying for the empty apartments.  How many are there? If we don't have a reasonably reliable number than all other numbers are fake too.

MFLTucson's picture

China has a 3.2 Trillion dollar currency surplus, I really think that can cushion the blow.  Need to put more thought into the 5 million homes sitting in off balance sheet accounts of the US banking cartel. 

FedMonger's picture

It is important to note that China Mainland Shanghai Composite Index is down some 70% off 2007 levels, the Dow is trading at less than 7% off 2007 highs. There are many China bulls out there. for sure there are bullish points as well as potential weaknesses. Two charts for perspective: one on china equity and one on china vs us in military stakes.

China Shanghai Composite Index, 2001-2012

US vs China Military Spending Chart 1989-2008

q99x2's picture

NWO going to attack China with the Japanese.

earleflorida's picture

16cents = U.S.$$$   *[no cents makes sense?]

Who's kidding who?  Dream on! That's all I can say, period! China has met or exceeded it's 5yr. program mandates to the 'T'... and guess what? That's right-- their next five-year plan is for internal growth and consumption, as plan'd!

They are a methodical culture that doesn't go off half-cocked on a impulsive buying binge to prove that their self esteem is for real!

Smog... go to LA, water pollution... just eat the fish from our rivers and great lakes... housing... just go to Chicago's south side... violence... just stay away from any American made urban nightmare with a population of 50k plus... and on and on she goes...

'America is a petrified salt-lick on the back-forty pages of history... a once fertile land now circling the wagons about the abattoir, masking the stench of inbreed'd corruption-- plowing for prime carrion!'

'The economic war is over. The future won,... always by attrition, with a new way forward. The past mistake never had a chance... forever siding with 'Uncle Jekyll' that should have stayed in Hyde'ing, man!'  

lmile61's picture

Who the hell is responsible for this can any one say!!!!!!!! magento development

luckylongshot's picture
When I read a comment like " the history of economic crises is packed with nasty surprises" I shake my head and marvel at how anyone could make such a wild generalisation and expect to be taken seriously. What economic history shows is a recurring theme of economic crises being caused by private bankers in order to accelerate their ongoing theft of public wealth. As China owns its central bank, there is not much risk of this happening there...however in America and Europe the Rothschild zionists have control and are busy preparing to unleash the next major crisis on the public so that is where the next raping of public wealth is likely to occur.