Bracing for the euro fallout

The South China Morning Post, June 17, 2012

As Greeks vote today in elections that may trigger the country's exit from the euro zone, Chinese industries are preparing for worse to come from the debt crisis

"Should I stay or should I go" could be Greece's new national anthem, amid rising fears over its ability to stay in the euro zone. It's possible exit is turning up the heat on Chinese industries and government officials as they brace for economic fallout that could dwarf that of the 2008 global financial crisis.

Today's poll in Greece could produce a left-wing government determined to stay in the euro zone but set on rejecting key conditions imposed as part of a European Union and International Monetary Fund bailout.

The make-up of the new government is likely to be a key focus at this week's Group of 20 summit in Mexico, when President Hu Jintao is expected to unveil China's proposals for rescuing the debt-laden euro zone.

Despite reassurances from European Union officials that the single currency will remain intact, political leaders have failed to agree on their own financial and fiscal responsibilities.
Fears of a so-called "Grexit" have surged in recent days, prompting a rise in bank withdrawals and capital flight and even hoarding of food in Greece.

Zhang Xiaoqiang, a vice-chairman of the National Development and Reform Commission - China's state planning agency - said Greece would stay put. But he said that solving the euro zone's problems was "a huge challenge" and the sovereign debt crisis had rippled across the world, exacerbating a slowdown in China's economic growth.

"The Greek election is a relatively small turning point," Zhang said. "Even if it withdraws from the trade bloc, the euro zone won't collapse. The biggest worry is the health of Spain's banking sector, which is bigger than that of Greece and is in trouble."

That problem was meant to be solved by a €100 billion (HK$980 billion) bank bailout package announced on June 9 - details will be settled after an audit of Spain's banks - but failed to soothe market nerves. On Thursday, yields on 10-year Spanish government bonds hit a euro-era record of 7 per cent - the level that triggered bailouts for Ireland, Portugal and Greece. The yield on Spain's benchmark 10-year bond stood at 6.874 per cent on Friday.

If a Greek euro exit had just half the impact on global growth that was seen after the 2008 global financial crisis, China's growth this year could fall to as low as 6.4 per cent, which would be the worst in 12 years.

Beijing is aiming for 7.5 per cent growth this year, while the World Bank is expecting 8.2 per cent. For the euro zone, HSBC economists expect it to contract 0.6 per cent this year.

Financial regulators on high alert

Hong Kong's financial regulators are already battening down the hatches.

Hong Kong Monetary Authority chief executive Norman Chan Tak-lam said contingency measures were in place if the euro-zone crisis continued to deteriorate.

He has warned the Exchange Fund's investment returns would be hit hard in the second quarter, largely because of global market volatility caused by the crisis.

"We are closely monitoring the sovereign debt crisis, and will adjust our currency and investment portfolio when needed," Chan said.

The investment income of the Exchange Fund, which is mandated to support the stability of the Hong Kong dollar, rose 76.6 per cent to HK$43.8 billion in the first quarter, powered by surging markets in Hong Kong and overseas.

The HKMA strengthens banks' reserve, capital and liquidity management and conducts stress tests on banks even though they do not hold any Greece sovereign bonds.

Hong Kong Exchanges and Clearing (SEHK: 0388announcementsnewshas raised margin requirements for Hang Seng Index futures.

The Securities and Futures Commission will soon require reporting of statutory short positions while carving out a regulatory framework for the over-the-counter derivatives market.

A government spokesman said chief executive-elect Leung Chun-ying would in August review the city's economic prospects against the backdrop of the euro-zone crisis.

Anthony Wu Ting-yuk, the chairman of policy think tank Bauhinia Foundation, said the biggest worry was that trade financing could dry up because Europe's banks needed to shore up their balance sheets and meet higher capital requirements at home.

He was also worried that European banks with substantial holdings in Greek bonds would be forced to write down their investments if Greece quits the euro zone and devalued its currency, prompting them to pull back from lending and trade financing, especially to companies in Hong Kong.

Weakened China trade and retailing

Some retailers and exporters, whose livelihood is closely tied to consumer demand and tourism in Europe, face a bleak future.

Yeung Chi-kong, executive vice-president of the Toys Manufacturers' Association of Hong Kong, said the Greek crisis had highlighted the urgent need for about 2,000 Hong Kong toymakers on the mainland to reinvest in innovation, technology and design.

Export orders had so far dropped 25 per cent from last year's combined sales of HK$150 billion for China, including Hong Kong, Yeung said.

"We are very passive because a Greek withdrawal from the bloc will depress the euro's value and consumer demand, and hence our export orders," he said. "This is a critical time for reinvestment in the future, or [the toymakers] risk being pushed out of the market."

Original equipment manufacturers, which make toys for brands they do not own, were most vulnerable to the consolidation, he said.

Yeung said European consumption would remain lacklustre for the next two years.
Torsten Stocker, a Hong Kong-based partner at management consulting firm Monitor Group, said: "The retail sector in China has undoubtedly been affected by the domestic slowdown and some of that can be linked to the crisis in Europe."

China's economy is slowing, with growth declining for the past five quarters. Following the same trend, retail sales growth slowed last month to 13.8 per cent - the weakest in 12 months - from 16.5 per cent in May last year.

Firms in acquisition mode

Some sectors stand to gain from the crisis, including the automotive and oil and petrochemicals industries, as they focus on merger and acquisition opportunities.

Liu Zhen, a special assistant to the president of Great Wall Motor - the first Chinese carmaker to open a production plant in the EU this year - said the crisis made Chinese brands more competitive.
"The crisis makes consumers more cautious about buying cars. They are turning from spending more for better quality to less for good quality," Liu said. "In terms of exploring the EU market with good products at lower prices, Chinese carmakers have more to gain than to lose."

However, given the crisis and a yuan-euro exchange rate at a new high, Europe is obviously not the priority destination for those looking to overseas markets. Bill Russo, a car industry consultant based in Shanghai, said China would rather focus on tapping high-growth markets such as Russia, the Middle East and Southeast Asia.

"The economic stress may provide some chances for Chinese carmakers to enter [the European market] in the entry-level, lower-price segments, but I think it's still in a very early stage," said Russo, a senior adviser at Booz & Co and president of Synergistics.

John Zeng, an analyst with LMC Automotive, said the debt crisis might actually help European carmakers lift market share in China.

"European carmakers now rely on the Chinese market more than ever. The weakening euro actually helps boost their competitiveness in China against their Japanese rivals," Zeng said.

However, neither Zeng nor Russo said the strong yuan and crisis would provide Chinese carmakers with bargains such as Geely's buyout of Swedish carmaker Volvo in 2010.

"The German government, for example, is very protective of its industry. It's not easy for a foreign investor to acquire crucial technology from a European carmaker even if they are under financial stress," Zeng said.

As the debt crisis hit Spain, Portugal and Italy, which have partially state-owned oil firms with substantial oil and gas assets, Chinese oil firms might be presented with opportunities to buy some of their assets, CLSA's head of regional oil and gas research Simon Powell said.

China Petrochemical Corp, the parent firm of the nation's largest oil refiner and petrochemicals producer, Sinopec (SEHK: 0386), agreed in November last year to buy a 30 per cent stake in the Brazilian unit of Portugal's largest energy firm, Galp Energia, for US$4.8 billion.

Property market to slump

Property analysts have also warned that a Greek exit from the euro zone would snuff out a nascent recovery in the Chinese property market.

"It will hit property market sentiment," said Eva Lee, the head of Hong Kong and mainland property research at UBS.

Centaline's chief executive for northern and southwest China, Dickson Wong Hung, said property sales and prices fell sharply in the 2008 global crisis. "When the economy's worsening, who wants to buy flats?" he said.

Unlike elsewhere, China's property market is largely led by government policies, rather than the market. Lee said the central government would loosen its tight controls to counter the impact of global turmoil.

"The crisis will hit Hong Kong directly, but the impact on mainland China will be cushioned," she said.
However, Alan Chiang Sheung-lai, the head of residential property at DTZ in mainland China, said he believed Beijing would be more cautious about relaxing austerity measures imposed to cool the property sector.

"Banks will tighten lending further because no one knows what will happen after Greek exits the euro zone," Chiang said. "Most people looking to buy a home will take a wait-and-see attitude."

Even if Beijing relaxes its measures, Wong said it would have a limited impact. "The financial crisis will hit the mainland economy. Even if the government relaxes its measures on the property market, it would only have a limited impact. It can't escape from the crisis," he said.

Denise Tsang, Enoch Yiu, Eric Ng, Anita Lam, Yvonne Liu, Celine Sun

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