Fitch: China Hard Landing Would Hit HK, Korea, Japan Hardest

A Chinese "hard landing" would have a significant impact on global growth and economic stability, with economies in Asia and major emerging market commodities exporters among the hardest hit, says Fitch Ratings. Besides China itself, Hong Kong, Korea and Japan would be the most affected major economies in the event of a sharp slowdown in Chinese GDP growth.

Fitch's base case forecasts China's economy to expand by 6.8% and 6.3% in 2015 and 2016 respectively. But in the latest Global Economic Outlook report, Fitch assessed an alternative scenario in which China's economic growth falls below 3% in 2016 driven by a collapse in public and private investment. Our assumptions in the shock scenario included a contraction in public investment of 4% in 2016 and deceleration in consumption growth to 5.6% in 2017 from 8.3% in 2014. This would result in asset-quality deterioration with a spike in the banking system NPL ratio to 8%, a cumulative 10% depreciation in CNY/USD, a double-digit percentage decrease in foreign direct investment and a peak to trough fall in home prices of over 4%.

According to the analysis, which used Oxford Economics' global macroeconomic model, the impact would be greatest within Asia. The resulting decline in trade combined with the regional investment exposures to China would weigh most on the export-centred economies of Hong Kong and Korea, with the cumulative reduction in GDP from the 2017 baseline amounting to 4.5pp and 4.3pp respectively. Japan would enter a deep recession, with the economy contracting in both 2016 and 2017 and its GDP down by 3.6pp by 2017 versus our base case estimates. Taiwan and Singapore would also face significant slowdowns, though not as severe, with GDP falling by 3.3pp and 3.0pp from the baseline respectively.

GDP growth in the Association of Southeast Asian Nations (ASEAN) economies of Indonesia, Malaysia, Thailand and the Philippines would be less affected by the direct feedthroughs of a China hard landing, though they would still face a cumulative GDP effect of around -2pp.

Australia would be affected to a similar extent as the aforementioned ASEAN economies. Australia has large exposures through its direct trading relationship with China, but it would be able to offset some of the negative impact through counter-cyclical policy. As a 'AAA'-rated developed economy, Australia benefits from sound fundamentals, which will help to stabilise the economy during a broader global downturn.

At the global level, a Chinese contraction would intensify deflation risks. This is especially the case for the euro zone, where demand has remained persistently weak and inflation low. That said, developed countries other than Japan would fare relatively better than their EM counterparts. Relative to the baseline, the cumulative effect on US and euro zone GDP would be -1.5pp and -1.7pp respectively, implying average annual growth rates of around 1.7% in the US and 0.8% in the euro zone for 2016-2017.

Major emerging markets outside Asia, especially the commodities exporters such as Brazil and Russia, would be doubly impacted by the effects on energy and materials prices and the risk premium shock that would raise borrowing costs and weigh on domestic demand. However, they would not be as heavily affected as the trade-reliant economies within Asia, with a Chinese hard landing likely to reduce GDP from the baseline by around 3pp for Brazil and 2.8pp for Russia.