Home / World Economy / World Economy News / APAC Exposure to Slower China Growth

APAC Exposure to Slower China Growth

Fitch Ratings believes there is a risk that further Covid-19 outbreaks could cause China’s growth to undershoot our current expectations, highlighted by the modest uptick in case numbers in July 2022 after the wave of cases in March-May subsided and many controls were lifted.

We expect China’s “dynamic zero-Covid” policy to remain in place well into 2023. Mass testing and localised controls should prevent another bout of economically disruptive lockdowns in 2H22. However, additional pandemic-related disruption in China could affect economic, fiscal and external prospects for other APAC sovereigns and territories, with possible credit implications through channels such as trade, tourism and financing. Risks to China’s Growth Significant for APAC Further Covid-19-driven economic shocks in China would have clear negative economic effects for Fitch-rated APAC sovereigns as China is the biggest export market for most. It is also an important supplier of intermediate products whose availability could be interrupted, affecting regional exports. Many Asian economies
have a high degree of trade exposure, amplifying the effect on GDP.

A significant slowdown in China would also represent the third major external shock in the last few years for APAC sovereigns, following the Covid-19 pandemic and the fallout from the Russia- Ukraine war. Successive shocks could further erode fiscal space and exacerbate credit risks in frontier markets, potentially eroding their political and institutional stability. Weaker near-term economic growth prospects would weigh on credit metrics for APAC sovereigns. Post-pandemic fiscal consolidation could be set back or reversed due to weaker growth or the use of fiscal stimulus to offset the external shock. Increased investor risk aversion linked to a China slowdown may also intensify capital flow volatility across the rest of the APAC region. This could add to financing strains for some sovereigns and territories, although many have substantial external buffers that could cushion the effect, at least for one or two years.
Vulnerability to a China Shock Would Vary Some sovereigns with weaker ratings, such as Laos (CCC), Pakistan (B-/Negative) and Mongolia (B/Stable), would face multiple exposure channels and their ratings may face downward pressure. India (BBB-/Stable), with fewer exports to China, is less exposed, although its high public debt level leaves little headroom to respond to broader external risk factors. For some other APAC sovereigns, potential threats to export demand may be mitigated by external buffers or rating headroom.
Further supply-chain disruption in China from Covid-19 restrictions could accelerate the diversion of export production from China, for example, to India and south-east Asia. This could create longer-term credit upside for some APAC sovereigns.

Risks to China’s Growth Outlook Remain China’s near-term growth outlook has become more challenging. Growth has slowed significantly relative to Fitch’s expectations in late 2021. Our latest forecast is for China’s economy to expand by 3.7% in 2022, down from a projected 4.8% at the start of the year. We forecast growth of 5.3% next year, which reflects a more subdued recovery from pandemic-driven disruptions than in 2021. With the government’s dynamic zero-Covid approach to controlling the virus likely to remain in place well into 2023, the recovery in activity is likely to be gradual and subject to potential setbacks. Policy support has been stepped up, but the easing measures announced to date have been relatively modest and could struggle to gain traction while social distancing measures remain prevalent. Our growth forecast remains subject to downside risks even after the recent revisions. If the authorities are unable to contain a major Covid-19 outbreak in 2022 or 2023, there could be further economically disruptive restrictions on activity that would cause growth to fall below our forecasts over the two years. China a Key Export Market Exports represent a large share of GDP in many APAC economies, making the region’s growth prospects particularly sensitive to developments that affect its exports and key trading partners.

China is the most important export market for 12 of the 20 Fitch- rated sovereigns and territories in ex-China APAC. This partly reflects its role as an assembler of components produced elsewhere in APAC for export to other markets, although its role as a source of final demand is substantial. China’s exports could also be affected in the event of further economically disruptive Covid-19 outbreaks, with spill-overs to demand for imported inputs from the rest of Asia

In addition to the hit to demand, it is also possible that exports to China could be dampened by restrictions imposed by the authorities to contain the spread of the virus. Mongolia’s coal exports to China, for example, were depressed during 2020-2022 by public health restrictions affecting cross-border truck traffic. China’s import growth slumped in March-May 2022 as the number of reported Covid-19 cases – and associated lockdowns – picked up. This was reflected in exports to China from some key APAC markets. Hong Kong’s exports to China dropped by 10.8% yoy on average in March-May. However, exports to China rose yoy from some other markets, such as Taiwan, Singapore and Malaysia, in March-May. The weakness in Chinese imports may also have reflected other factors; imports rose just 0.2% yoy in June, slower than in May, even though lockdowns had eased. Import Disruption Another Risk Vector China is also an important source of imports for much of APAC. A disruption in Chinese exports would therefore have knock-on effects for manufacturing supply chains across the rest of the region, which could further hamper other countries’ export prospects and add to inflationary pressure.

We consider Hong Kong, Singapore, Taiwan, Vietnam, Malaysia and Korea as the APAC sovereigns and territories most exposed to economic shocks stemming from supply-chain disruption in China, as their exports are a large part of GDP and they are highly reliant on inputs imported from China. Singapore’s share of imported inputs from China is lower than the others, but this is offset by the greater importance of trade within its economy. Interruptions to imports from China could also push up inflation, if sourcing alternative suppliers proves more expensive. We would expect this risk to be greater in economies that import a higher proportion of their goods from China.

Nonetheless, we think supply-chain interruptions within China stemming from pandemic controls – and associated disruptions to imports in the rest of APAC – are unlikely to persist into the medium term.

Commodity Price Channel
China, a crucial market for many global commodities, is the world’s biggest importer of products such as crude oil, copper, soybeans,
coal and iron ore. We believe weaker growth in China could put downward pressure on global commodity prices, particularly in the context of slowing economic growth in the US and the increasing possibility of a technical recession in the EU associated with reduced gas export volumes from Russia. However, a near-term undershooting on growth could be followed by additional stimulus spending on infrastructure by the Chinese authorities. This would support prices for construction-related commodities, although the net price effect would depend on the elasticity of supply and trends in other important sectors such as property development.

In APAC sovereigns where commodity exports are an important growth driver, such as Australia and Indonesia, weaker commodity prices may have adverse effects on credit metrics, notably GDP and external finances. Still, prices would be easing from a very high base.
Most Asian economies are net energy importers and are likely to benefit from an improvement in their external position if weaker Chinese demand dampens global prices for fossil fuels. Malaysia is a notable exception, as weaker oil prices would reduce its oil revenue and add to fiscal pressure. However, this potential scenario needs to be viewed in the context of ongoing geopolitical uncertainties that have kept energy prices elevated. Chinese demand for essential goods, such as food, held up relatively well during previous bouts of Covid-19-related disruption to the economy. We expect agricultural commodity prices to be resilient if further outbreaks disrupt China’s near-term growth. This would be supportive for Australian beef and grain exports, New Zealand dairy exports and south-east Asian fruit exports, for example. Chinese Tourism Recovery Prospects China’s current restrictions on cross-border travel act as a significant deterrent to potential outbound tourism flows. Since we assume the dynamic zero-Covid policy will be relaxed only gradually from 2023, it is unlikely that further outbreaks within China in 2022 would have significant additional knock-on effects on the already depressed outbound travel flows by Chinese tourists. The recovery, when it comes, will play an important role in supporting regional economies where Chinese tourism was formerly an economic growth driver, such as Hong Kong, Thailand, Sri Lanka, the Philippines and Vietnam. The return of Chinese tourists could also play a positive role in some economies where tourism is a less important growth driver, such as Korea and Japan

The relaxation of restrictions on cross-border travel will also be important for Australia and New Zealand, where Chinese students were a significant pre-pandemic driver of demand for education service exports. China’s Outbound Financing Chinese FDI and financing for infrastructure may become more constrained if China reduces its bilateral lending and Belt and Road Initiative investments, but we think the risk of these being affected by domestic economic considerations is quite modest. This could come about as a result of redirecting Chinese policy bank lending towards domestic priorities, or a change in the risk appetite of Chinese financial institutions towards lower-rated sovereigns, given the negative impact that the successive economic shocks of recent years have had on the latter’s credit fundamentals. Bilateral support from China has become even more important for a number of frontier markets as the global financing environment has become more challenging since 2020. We believe this will be particularly important for APAC frontier markets that have strong links with China, such as Laos and Pakistan.

Fitch does not expect China’s willingness and ability to provide financing support for these nations to be significantly affected by a potential slowdown stemming from Covid-19 control measures, which are likely to be temporary. The funding amounts are also relatively small from China’s perspective in most cases. In Sri Lanka and Pakistan, where they are not, the funding is weighed against important geostrategic priorities. However, growing financial distress in these countries could alter the political calculus for additional Chinese support. The IMF may also decide to attach conditionality around new debt funding, including bilateral debt, as part of its lending programmes to Pakistan and Sri Lanka. Yuan Could Come Under Pressure The yuan may come under further downward pressure if the Chinese economy underperforms market expectations, particularly against the background of monetary policy tightening in the US.
This could influence monetary policy decisions in other parts of APAC, since policymakers in the region are conscious of the effect of a weaker yuan on their trade competitiveness vis-a-vis China. In this scenario, the spectrum of outcomes for APAC economies is nevertheless challenging to predict, as regional policymakers would also balance other considerations such as domestic inflation dynamics and potential pressure on foreign-exchange reserves, which has already increased amid US monetary tightening.

If policymakers choose to prioritise exchange-rate competitiveness over price stability and we assess that monetary policy credibility is
being eroded, this could have adverse implications for creditworthiness in some sovereigns. However, this impact could be offset by factors such as the positive effect on external accounts. Rating Impact Would Vary Under the hypothetical scenario in which China’s growth slows significantly below our current forecasts as a result of further outbreaks of Covid-19, we believe slower growth and weaker global investor sentiment – leading to capital outflows and tougher access to external financing – will be the main channels through which other APAC sovereign ratings are likely to be affected. Weaker exports, including the effects of disruption to supply chains within China, would weigh on near-term growth prospects, which would directly impact credit metrics in our sovereign rating model.
The effects across the APAC region may be largely transitory, but this additional shock after the pandemic and the Russia-Ukraine war may raise the risk of economic scarring that could weigh on medium-term growth prospects. Ratings that are sensitive to this risk, with relatively limited headroom, such as that of the Philippines (BBB/Negative), could face downgrade pressure.

Fiscal headroom is also limited in India (BBB-/Stable). However, India’s export exposure to China is low. This suggests that its direct vulnerability to weaker Chinese growth is relatively modest, although India could still be affected indirectly, for example, through higher financing costs if international investor risk aversion increases as a result of a weaker growth outlook for China.
Tighter financing conditions would also have negative repercussions for the creditworthiness of sovereigns with more stretched fiscal and external positions. In the case of Pakistan, Laos and potentially Mongolia, the prospects for financing support from China could have an influence on sovereign rating trajectories. Other APAC sovereigns and territories have more headway to absorb the adverse effects of a Chinese slowdown on their GDP and external metrics at their current rating level. Many, such as Taiwan and Korea, have significant external buffers that would help to cushion the effects of a short-term shock to China’s GDP growth.

Nonetheless, there could be a deterioration in public finances compared with our baseline expectations, particularly if governments use fiscal stimulus to offset the effects of weaker exports. In the wake of the significant increases in public debt in much of APAC during the pandemic, this would pose credit challenges for several sovereigns

Increased Risks to China’s Rating
When we affirmed China’s rating at ‘A+’ with a Stable Outlook in June 2022, we said that a continued rise in macro-financial risks, for example, through failure to maintain credit growth at a level close to nominal GDP growth over the next few years, could lead to negative rating action. If further outbreaks of Covid-19 cause these risks to escalate significantly and do ultimately result in negative rating action, this could also lead to potential negative rating actions on the Chinese territories of Hong Kong and Macao, given their strong economic and credit linkages with mainland China.

Full Report

Source: Fitch Ratings

Recent Videos

Hellenic Shipping News Worldwide Online Daily Newspaper on Hellenic and International Shipping