China's disappointing June trade numbers has the market murmuring about the Chinese hard landing scenario.
To be clear, China doesn't have to be in a recession to be in a hard landing. Indeed, any significant slow down from its roughly 8% current pace of growth would be disruptive.
The Chinese government has a target growth rate of 7.5% right now.
Morgan Stanley's "Super Bear" scenario has GDP slowing to 5.5% later this year and 4.5% next year.
"The prospect of financial sector deleveraging in China increases the risk of a hard landing," said Morgan Stanley's analysts this week. "Although the probability of the hard landing is still low, it’s not low enough to make hedging costs irrelevant."
Indeed, China's economy is so levered that the BIS warns its at the risk of an all-out credit crisis. And China's regulators appear to be directing the economy in a way to take some of that leverage out, even as interest rates surged.
"The new government’s policy drive to deleverage the banking sector has become more apparent," said Morgan Stanley. "In the three months preceding the spike in money market rates, the CBRC/SAFE have announced measures to regulate interbank entrust payments, wealth-management products, leverage in bond investments, FX lending and interbank loan structures, all with the aim of curtailing the widespread use of new financial channels to grow bank assets rapidly. We think that this deleveraging will likely continue to unfold in the next 6-12 months."
So, how will it all unfold?
"In the super- bear scenario, we expect aggressive policy tightening in credit policy on LGIVs (Local Government Investment Vehicles) and property developers," continued Morgan Stanley. "The government will likely slow down the fiscal expenditure growth and adopt additional administrative measures to curb property demand. We expect the government to use aggressive moral suasion and other regulations to slow down loan growth, especially loans to LGIVs and property developers."
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