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China slowdown set to hit EM exporters

Men ride bicycles past construction sites near the headquarters of China Evergrande Group in Shenzhen, Guangdong province, China September 26, 2021. REUTERS/Aly Song

Debt defaults by China property giant Evergrande have sent a loud wake-up call to the risks for emerging economies from China’s economic transition

Property developer Evergrande’s crisis has woken financial markets to the challenges facing the Chinese economy, but concerns go far beyond the property sector as China’s transition to a slower growth model could mean a rocky growth path for emerging economies.

Debt defaults by Evergrande and its peers will, by themselves, have limited long-term effects on emerging markets. But the Chinese real estate sector — which has been responsible for much global commodity demand in the last two decades — is still expected to slow sharply.

Gustavo Medeiros, deputy head of research at EM-dedicated investment manager Ashmore, said the main risk from Evergrande would be if the sector’s slowdown was mismanaged, allowing the property development crisis to become a housing crisis.

“If house prices plummet then it would be ugly, and the vast majority of Chinese wealth is in housing,” said Medeiros. “But Beijing is aware of this and is ring-fencing companies like Evergrande to ensure that housing companies continue to develop.”

A structural slow-down in homebuilding as urbanisation slows would still have a fall-out for other EM nations. Capital Economics, a London consultancy, says the main effects will be felt in metals producers in Latin America and Africa, arguing it is an additional reason to expect “weak long-term growth” in Brazil and South Africa.

Graham Stock, head of EM sovereign research at BlueBay Asset Management, added. “The main issue [for EM investors today] is that if we really are looking at weak growth in China it is a problem for export markets.

“Financial issues in China are in the property sector, but the concerns are broader than that, including production restrictions at the provincial level and restrictions on polluting industries that could potentially lead to reduced demand for iron ore, in particular.”

EM suppliers face slowdown

After average annual growth of 7.7% between 2010-2019, estimates for Chinese GDP expansion over the next decade are in the range of 4%-5%. Other investors agreed that, as Chinese authorities guide the economy into a lower growth model, countries that export to China will face challenges.

“If any countries are relying on a continued acceleration of Chinese growth, they probably need to rethink their macro policies,” said Simon Quijano-Evans, chief economist at Gemcorp Capital. “Growth will be dampened because China can’t afford to get itself to a place where the demand for commodities is constantly higher than supply.”

Medeiros said this was a fair assessment but noted that a slower rate of growth by today’s larger Chinese economy would deliver a comparable level of expansion to when the economy was growing at a higher rate 10 years ago, yet from a smaller base.

“This is a transition to higher quality growth that the authorities have been trying to do for a few years,” said Medeiros. “There may be some stress as the property sector de-levers, but there are options to replace real estate jobs as China invests to become a high value added industrial economy.

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