Hong Kong links make Britain more exposed to China slump, BOE warns

THE UK is more vulnerable to a Chinese economic crunch than was previously realised because Britain’s financial links to Hong Kong were not fully studied, the Bank of England has said.

Direct economic links with China are relatively limited – only 4pc of UK exports – and China does not hold a large proportion of global assets or liabilities. But Britain’s links with the eurozone, which does more trade with China, and its financial ties to Hong Kong mean the full danger a Chinese recession poses to the UK is around 50pc bigger than previously thought.

“China’s credit boom is one of the largest and longest running ever recorded,” the Bank warned in its quarterly report. “Similar credit booms have typically preceded crises in other countries. We find that the effects via standard channels from a modest fall in Chinese GDP are larger than our previous estimates, primarily due to China’s increasing role in global trade.”

China’s economy is growing by almost 7pc per year, but the IMF has forecast it will slow over the next two years, reaching 6.4pc by 2019. If it fell by three percentage points over two years, the UK economy would likely slow by around 0.5pc, the Bank warned. A bigger economic shock would be far more amplified, due to the spill-over into the financial markets.

“The UK is unique in having both sizeable direct exposures to mainland China and indirectly via UK banks’ exposures to Hong Kong,” said the report. “Together, UK banks’ exposures to mainland China and Hong Kong exceed exposures to the US, eurozone, Japan and Korea combined, despite the UK economy being a fifteenth of the size of these economies.”

If China suffered a small recession, or a “hard landing”, this would cause much greater turmoil. The last time China’s gross domestic product fell was in 1976. The Bank’s stress test looks at the result of growth falling from almost 7pc to a fall of close to 1pc, before recovering, with a net result of a 10 percentage point fall in the expected level of GDP over three years. “This illustrative scenario for a Chinese hard landing could reduce the level of UK GDP by 0.9pc to 1.0pc after one year and 1.3pc to 1.4pc at the peak,” said the report.