Economic growth in China has brought significant benefits to LICs and LMICs through growth in exports to and foreign direct investment (FDI) from China. However, the Chinese economy has been slowing, and there is increasing concern about risks to financial stability from real estate ‘bubbles’, the growth of the shadow banking system and high leverage in the local government sector.

Policy responses to constrain credit growth have been undermined by regulatory gaps and arbitrage, failure to fully recognise bad debts and the risk of repeated ‘mini’ stimuli further inflating real estate markets, making a ‘soft landing’ increasingly difficult to manage (the ‘Greenspan put’). More decisive policy action is needed.

The IMF and OECD forecast a slowdown in gross domestic product (GDP) growth to 7.0% for 2015, 0.7% below the 2013 rate of 7.7%. We believe this is overly optimistic and estimate a slowdown to 5% by 2015/16 with decisive policy action – and to below 4% without – based on comparative financial crisis as an alternative to IMF dynamic stochastic growth models (DSGEs).

Developing countries, including LICs and LMICs are likely to experience short-term negative effects of a slowdown in China because of their export dependency but if  they restructure their export composition the longer-term structural changes in China offer opportunities for them to renew growth. Further research and policy support to assist in anticipating and seizing these opportunities is needed.

This paper examines the implications of this scenario for LICs and LMICs, identifying those countries that are vulnerable to a slowdown in China.

Judith Tyson, Jane Kenan and Zhenbo Hou