The ultimate risk to China may be deflation, warns Ambrose Evans-Pritchard.
“A credit crunch is highly probable,” said the bank in a report entitled “Deflation, Devaluation, and Default”, written by David Cui and Tracy Tian.
Last week, Chinese inflation data showed CPI at 1.5% y/y but downward pressure is in the pipeline because of falling commodity prices. The producer price index fell 3.3% y/y.
“The most likely scenario is a bad debt surge as growth slows, followed by a credit crunch in the shadow banking system, followed by a major recapitalisation of the banks,” said Mr Cui.
It’s a AEP, so take it with a grain of salt. But if Chinese leaders start to worry, there is plenty they can do to boost inflation and the knee-jerk in markets will be Australian dollar strength.