26 August 2015

Forbes: How exposed Is Europe to a Chinese economic slowdown?

European stock markets posted their worst day since the 2008 crisis yesterday with the FTSE 100 closing down 4.7%, the German DAX 4.7%, France’s CAC 5.4%, Spain’s IBEX 5% and Italy’s FTSE MIB 6% off the back of huge falls in Asian markets. Much of this has been linked back to huge falls in Chinese and emerging market equities. While this link should not be overdone – China was likely a catalyst if not the cause of such a huge market shift (after all how much actually changed over the weekend) – it provides an opportunity to ask the question, just how exposed is Europe to a slowdown in China?

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Where are European exposures to China and how large are they?

Despite some tensions and trade disputes (over solar panels for example) China and Europe have seen a sharp rise in their interconnectivity over the past few years.

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Given that financial markets in China remain relatively closed the exposure here is limited, even with exposure via Hong Kong factored in. As the chart above shows, bank exposures have increased over the past few years though remain relatively small with China accounting for only 2.2% of European banks foreign claims and Hong Kong for 3%. However, the large majority of this exposure is driven by the UK, as shown in the chart below. This is not surprising given that two of the UK’s largest banks – HSBC and Standard Chartered – have significant business in Asia. [...] Overall, it is unlikely that the financial sector would be a significant channel for serious and permanent concerns to spread from China to Europe. 

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As the table below, via the European Commission, shows China has become one of the EU’s key external trading partners in goods. It ranks 2nd overall in terms of total trade and in particular has been a key source of demand for exports in recent years. At a time when the Eurozone is struggling it should not be underestimated as a source of external demand and cheap inputs. While it is important in terms of goods trade, total trade in services is relatively limited at the moment totalling €50bn in 2013.

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In terms of the types of products, trade between China and the EU is heavily focused around industrial products and manufactured goods in particular. Within this the balance is heavily towards machinery and appliances as well as transport equipment. From this is instantly clear that Germany will be the key player in this trading relationship. This is driven home by the fact that in 2014 Germany exported $99bn worth of goods to China, this compares to $21bn for France, $14bn for Italy and $5.4bn for Spain. As such Germany alone accounts for close to half of all EU exports to China and is far more exposed via trade channels than other EU states and particularly Eurozone states. [...]

What does all this mean the European economic recovery?

It’s clear from the above that Europe does have some exposure to China. Any slowdown in China and emerging markets more broadly might hamper the fragile economic recovery which is in place in the Eurozone.

There could also be double whammy in terms of lower demand but also a stronger euro. [...] Serious slowdown and financial jitters in these markets can drive inflows into the Euro both through safe haven flows and investors repatriating funds since the Euro has become a funding currency (as well as short covering in this case), pushing the Euro higher and undoing some of the work of the ECB. Furthermore, on a trade weighted basis the Euro has gained over 10% since its lows in April. It is also worth noting that the Eurozone’s entire crisis response has been to try to make economies more competitive and reorientate them towards exports and external demand. This combination is a reason to be concerned about potential souring of external dynamics which includes China, emerging markets and monetary policy tightening in the US and UK.

That said, this should not be overdone just yet. The safe haven flows mentioned above will help in terms of money flowing into the Eurozone. The continuation of and potential increase of ECB QE along with low oil prices, which will likely stay lower if China struggles, will continue to aid the European economy. Additionally, while China is one of the EU’s largest external trade partners, it ranks fairly low for most individual countries in terms of trade as much of their trade is with other EU states or the US. Whilst the idea has been to create an export driven recovery, it is also not clear that this is what has happened so far in the Eurozone.

Germany has brushed off concerns that turmoil in China could impact its economy with Chancellor Angela Merkel saying, “China will do everything in its power to stabilize the economic situation” and a spokeswoman for the Economy Ministry saying the “immediate consequences” should be “limited”. [...]

As of yet then, it is probably not time to panic in Europe with regards to the turmoil in China and emerging markets – as the recovery in European markets today suggests. However, if a serious and sustained slowdown does emerge in China it will pose some tough questions for a still fragile European economy.

Full article on Forbes (with charts)

© Forbes