The euro area is at “significant” risk of a sharp readjustment of China’s economy, according to research by the European Central Bank.
A swift rebalancing of the world’s largest exporter — where aggressive reforms hold back gross-domestic-product growth by about 3 percentage points in three years — would slow the currency bloc’s economic expansion by about 0.3 percentage points.
This may not be much in the face of growth expected to top 2 percent this year and the next, but it’s based on the assumption that the shockwaves of such an event across the world’s economy would be limited. Taking into account larger effects on trade, foreign exchange and global financial markets, the slowdown would amount to 1.2 percentage points.
And that’s not even the worst scenario. An “abrupt adjustment” in China — with GDP shrinking 9 percentage points through 2020 on the back of a sharp financial tightening — would slow euro-area growth by 1.5 percentage points even under the more conservative assumptions.
Such outcomes are not the ECB’s baseline. The central expectation is for a limited rebalancing with gradual reforms and, consequently, continuously slowing growth. And while there are risks, especially in the financial sector, China has ample “policy space” to counter a slowdown, thanks to its vast reserves and current account surplus, the ECB said.
“China has been the economic success story of the past four decades, but economic growth has been slowing and vulnerabilities are increasing,” according to the article, which was published on the ECB’s Economic Bulletin on Thursday. “Spillovers to the euro area would be limited in the case of a modest slowdown in China’s GDP growth, but significant in the case of a sharp adjustment.”