Discover (or rediscover) the best of our research this holiday season: in focus – China’s economic slowdown and Germany’s next ‘Wirtschaftswunder’

This year, our economists shared their expertise on everything from supply chain disruptions to SPACs. Stay tuned for our picks to discover (or rediscover!) the best of our research this holiday season, or dive right in here. Here’s to new beginnings: Wishing us all a Happy & Prosperous 2022!

China’s great crunch: Causes and consequences, at home and abroad

How long could China's economic slowdown last, and what does it mean for the rest of the world? Read our full report here.

A mix of temporary and policy-driven crunches, the biggest being real estate, has sparked a sudden slowdown in China, which we expect to continue through Q4 2021 and the beginning of next year. As a result, we cut our GDP growth forecasts to +7.9% in 2021 and +5.2% in 2022, from +8.2% and +5.4%, respectively. This compares with consensus expectations at 8.1% in 2021 and 5.3% in 2022 as of October. Policy tightening and delta outbreaks have crunched cyclical activity but we do expect these factors to fade away. A recovery of services is likely going forward, although a return to normal will be hindered by the zero-Covid strategy likely to last well into 2022. In addition, “common prosperity” and increased regulatory scrutiny should keep industrial activity and the real estate sector under pressure. We expect at most a pause and/or softening of authorities’ communication in the regulatory crackdown against the real estate sector. This means that housing activity will remain weak and further defaults among real estate developers can be expected – even though policymakers have the means and intention to avoid a systemic crisis. Other areas of increased regulatory scrutiny include energy and local government finances, but they could be eased to mitigate the impact on short-term growth.

What could go wrong? The risk of policy mistakes has increased. We think risks remain tilted to the downside and much relies on policy coordination and reactivity to help the economy navigate the multiple crunches that are occurring at the same time. The main domestic risk comes from the real estate sector deteriorating further in a long-lasting way, with spillover impact on other sectors of the economy. Indeed, accounting for downstream and upstream sectors, final demand generated by real estate accounts for c.25% of China’s GDP and housing represents 78% of household assets, 40% of bank loans are backed by properties and land sales amount to roughly one-third of local governments’ gross revenues. The main external risk is geopolitical as renewed tensions emerged in the Taiwan Strait and with the US. The likelihood of an actual conflict remains extremely low and we continue to expect a status quo in US-China trade tariffs, although non-tariff barriers could increase. In the long run, the situation denotes the US’s intention to further deploy its containment strategy against China.

What does China’s slowdown mean for the rest of the world? From a global supply perspective, the Chinese economic slowdown could further raise the cost of trade and global input prices, lengthen delivery delays, and even worsen production shortfalls in the US and Europe. From a global demand perspective, exporters to China could suffer, particularly those exposed to the construction and metals sectors (i.e. Chile, Hong Kong, Peru, Australia and South Africa). Conversely, exporters of energy and more precisely thermal coal (particularly in Indonesia, Malaysia and Australia in Asia-Pacific) are likely to see rising demand in the context of the ongoing energy crisis in China. Beyond the short to medium term, countries dependent on Chinese demand will need to deal with its adjustment to a lower growth regime (average between +3.8% and +4.9% in the coming decade), and the ensuing risks. The changing economic model could also alter exporters’ exposures (heavy industry and construction vs. consumption and high technology goods). Looking at financial markets, we find that spillovers from China to the rest of the world are more likely in equities than corporate credit, but in both cases more likely in the event of significant negative performance in China. During the 2015 China market crash, a -10% drop in Chinese equities would have driven Japanese and Asian equities down by -2.5% and -1.9%, respectively, while Chinese credit bonds falling by -1% drove down EM credit by -11bps (all other things being equal). Since then, access to Chinese assets have opened further, meaning that a market rout in China could have even more damaging consequences, and potentially well beyond Asia and emerging markets.

How to future-proof the German 'Wirtschaftswunder'

"Business as usual" won't be enough to prepare Germany for the green, digital and demographic transitions. Can its new government kick off an economic ‘Neustart’?

Political change is upon Germany, but no major policy overhaul is in the cards. After the elections on 26 September 2021, Chancellor Angela Merkel will be replaced after 16 years in power. The transition takes place in a highly fragmented political context, which will likely see the first three-party coalition emerge at the federal level and complicate the government-formation process. The significant dilution of agendas required for an agreement among potentially uneasy political partners suggests that German politics will see more policy evolution than revolution over the next four years. Yet, Germany needs an economic ‘Neustart’. Unfortunately, “business as usual” with at best small, piecemeal reforms are not going to cut it anymore. Germany urgently needs a major update to ensure that it can master successfully the digital, green and demographic transitions and in turn safeguard its prosperity.

Making the economy fit for the 21st century: Most parties seem to lack comprehensive and concrete plans, though it is high time to finally tackle the well-known reform ?biggies“. These include future-proofing Germany’s institutional backbone (reform and modernization of its federal structure and public administration), cutting red tape, providing critical (digital) infrastructure, reforming its education system and fueling the entrepreneurial spirit. Taken together, these are the prerequisites for a faster pace of digitization, which in turn is crucial not only for an effective fight against Covid-19, but also for achieving climate targets and maintaining an internationally competitive economy. Meeting the magic number to limit climate change. The policy targets in almost all of the election manifestos are insufficient to limit global warming to 1.5°C. Carbon prices need to rise and additional policies are required to establish new technologies and new markets, and to adapt to the already material damages resulting from climate change. This will affect heating, transport and food prices and thus particularly burden financially vulnerable households and businesses, which calls for revenues from carbon-pricing policies to be used for providing adequate support in the form of transfers and stable electricity prices. Adapting to demographic change. Most parties shy away from pointing out the need to adapt Germany’s pension system, promising further increases of benefit levels and freezing the retirement age at 67 instead. However, these promises will come at the cost of a markedly higher tax-financed state subsidy of the pension system or a contribution rate of 30% in the long run, which would mean either curtailing the financial scope for investments in infrastructure, education and new technologies or undermining Germany’s competitiveness, not least in the (global) war for talent.