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Implications of a slowdown in Chinese growth

An article from the November 2022 Financial Stability Report.

China is a key driver of global economic growth and New Zealand’s second largest trading partner. Consequently, New Zealand is particularly exposed to spill-overs from economic and financial risks in China. In recent months, China’s economy has faced multiple headwinds stemming from a weakening property market and successive COVID-19 lockdowns. This article discusses the implications of a slow down in the Chinese economy for New Zealand.

China’s COVID-19 management strategy continues to involve strict lockdowns and mobility restrictions in areas of outbreaks. Authorities remain committed to this strategy to reduce strain on the health system, partly given low vaccination rates among older populations. Such measures impose significant constraints on local economic activity, although over time authorities have adjusted the restrictions to mitigate disruptions to transport, supply chains, and businesses.

Alongside headwinds from containing COVID-19, parts of China’s property development sector have come under severe financial strain. Rapid urbanisation and real estate development have been an important source of wider economic growth.

Moreover, local governments in China have long depended on ongoing property development related revenue to fund their own investment activities and provision of services.

After the emergence of financial difficulties among some large property developers with highly leveraged business models, authorities introduced new regulations to restrict financial risks among property development companies. In addition, falling consumer confidence has seen new home sales decline 34% in the past year and future development pipelines appear set to fall considerably. With the drop-off in new home sales, which would previously have been a source of fresh liquidity, financial conditions for developers have tightened significantly in the past year. Analysis by the IMF suggests that around 45% of developers may not be able to pay their debt obligations with current earnings, while around 20% could become insolvent.
New residential real estate sales and construction starts

Download the graph of new residential real estate sales and construction starts (jpg, 330 KB)

More recently, many home buyers are reported to have stopped making mortgage payments on incomplete housing projects, highlighting the concerns which have spread from financial markets to households. Stalling development projects that end up in default may have very low recovery rates, which could lead to contagion to the rest of the economy through a hit to banks’ capital. In aggregate, around 8% of total lending is to property developers, with another 20% to mortgage borrowers. While stress testing by the People’s Bank of China suggests larger banks would be resilient to a property-driven downturn, the greater risk lies with the smaller, less well capitalised banks that have a higher exposure to the property development sector.

Given these challenges, forecasts for economic growth have been repeatedly revised down this year, and a further deterioration remains a possibility. Weaker activity is evident across a number of indicators.

Manufacturers’ expansion intentions remain weak due to ongoing lockdowns, recent heatwaves and electricity shortages. Retail sales have continued to be suppressed by low consumer sentiment.

Loan demand and consumer confidence

Download the graph of loan demand and consumer confidence (jpg, 353 KB)

Index of loan demand measures the net percentage of bankers’ assessments of loan demand, with a result above 50 indicating demand being above normal. Consumer confidence measures confidence on a scale from 0 to 200, with a result above 100 indicating general consumer optimism.

Implications for New Zealand

A slowdown in China’s growth would affect New Zealand through its impacts on trade, financial markets, and uncertainty.

  • China has been a major driver of global economic growth and trade in the past decade. Australia is an important supplier of many of China’s key raw material imports for construction, and is therefore directly exposed to a contraction in property development. A slowdown in Australia's economic activity would have significant flow on effects to New Zealand's economy, for example through a reduction in demand for our tourism and food exports. Additionally, emerging Asian economies with economic growth closely tied to China's, are also important export markets for New Zealand. New Zealand’s exporters have a relatively limited direct exposure to China’s property development sector, with our main exports being dairy and meat products. However, a general slowdown in Chinese household consumption would likely affect our meat and dairy exports. A more direct link to property development is New Zealand’s forestry exports, with around threequarters of our logs exported to China. In the event of a greater slowdown in Chinese growth, export prices could decline, putting pressure on the New Zealand dollar exchange rate to depreciate, contributing to domestic inflationary pressure.
  • Foreign investors hold around 4% of China’s total outstanding bonds, limiting their direct exposure to financial losses. Credit growth is likely to wane as confidence in future housing construction by home buyers declines. Stress in the property development sector has contributed to an easing in monetary policy settings in China in an effort to stimulate economic activity, particularly as the Federal Reserve has tightened its policy rate. This has contributed to a historically large depreciation in the Chinese yuan relative to the US dollar in the past 6 months.
  • Due to the scale of the downturn in China’s real estate sector and the role China plays globally, uncertainty around Chinese growth prospects affects global risk sentiment. This shapes sentiment in New Zealand and thus is likely to affect investment and spending, along with other risks to global growth.
  • We continue to monitor financial stability risks in China and their potential impact for New Zealand. Chinese authorities will likely act in the event of a financial stability crisis and hold extensive assets and foreign reserves to do so. External debts are minimal and central government debt is low. Furthermore, large parts of China’s banking system are state owned. This suggests that the central government has the capacity to intervene to stabilise financial markets, and provide direct support to the banking system and local governments if necessary. However, addressing vulnerabilities in the financial system and achieving a smooth transition away from investment edgrowth remains a challenge, and may entail a long period of slower growth than China has seen in recent decades.