beyondbrics

There was another sobering report from the IMF on Monday, hot on the heels of some gloomy stuff from the World Bank and the Fund itself. Monday’s warning: fallout from the eurozone crisis could knock as much as four percentage points off growth in China’s GDP – almost halving the expected 2012 growth rate.

So much for a soft landing. Should we sound the alarm?

The IMF’s China Economic Outlook starts cheerily enough, noting that China remains “a bright spot in an unpredictable global economy”. Inflation is coming down. The property bubble is gently deflating. All seems rosy, then… bang: there is “A clear and present danger emanating from Europe”.

From the report:

The most salient risk is from an intensification of feedback loops between sovereign and bank funding pressures in the euro area, resulting in more protracted bank deleveraging and sizable contractions in credit and output in both Europe and elsewhere.

Should such a tail risk of financial volatility emanating from Europe be realised, it would drag China’s growth lower. The channels of contagion would be felt mainly through trade, with knock-on effects to domestic demand. In the downside scenario… China’s growth would fall by around 4 percentage points. The risks to China from Europe are, therefore, both large and tangible.

Large and tangible indeed: as the FT’s Jamil Anderlini noted recently:

the Communist party has formulated economic policy on the assumption that 8 per cent GDP growth is the minimum needed to stave off the social instability that could threaten one-party rule.

What’s to be done?

According to the IMF, the key resposnse should be a fiscal stimulus worth around 3 per cent of GDP. The Fund says this should consist of cuts in direct taxes and social contributions along with subsidies for consumption of consumer durables and support for small businesses – in contrast to the big public infrastructure-led stimulus of 2008. This would keep the stimulus away from the banking system, avoiding any further balance sheet risks. The effect of the stimulus is shown in the chart (left).

In the IMF’s January World Economic Outlook Update, the eurozone was only one of several downside risks cited – a US and/or Japan slowdown was another, along with oil supply risks. But clearly it’s the eurozone that is weighing heaviest on the minds of the IMF.

The big question then is: how likely is the “downside scenario” to come about? The IMF gives no guidance on that. For the time being, it suggests China should fine tune monetary conditions to allow for modest additional credit to the economy.

It would also be worth having that stimulus ready. Just in case.

Related reading:
China: rural economy is growth back-up, FT
12 for 2012: China will go slow for longer, but a hard landing is unlikely, beyondbrics
China growth: still up in the air, beyondbrics
Letting China’s economy bloom, FT