With global markets wobbly, the US economy weakening further and many now arguing that China will be the next to feel your pain, let me restate my view on the Chinese economy.
I continue to have high convictions on two points. First, a US recession and European slowdown will only shave about 100 basis points off China’s actual GDP growth rate this year, dropping it to 8-9%. Second, monetary and fiscal policy will not be significantly tighter than last year. Additionally, the consumer price index (CPI) is likely to stay at about 6% for the first half of the year before slowing considerably from July.
The American minority
When looking at the impact of a US recession, it’s important to note that Europe now accounts for 26% of China’s export growth, 19% comes from the combined markets of Latin America, the Middle East and Africa, and the US only has a 10% share. If Europe slows but does not go into recession, and if high commodity prices keep spending up in resource-exporting countries, then the impact on China of a steep slowdown in US import growth will be lessened.
Chinese goods remain very price-competitive, particularly at the lower end of the market. As households and firms cut back, they will increasingly turn to lower-priced Chinese goods to stretch the dollars they do spend. This means the country’s export growth will take a significant hit, but a much lighter hit than other exporters.
Most importantly, net exports account for only about 20% of China’s nominal GDP growth. The majority of growth comes from domestic investment and domestic demand, and all the indicators show that although the domestic economy is slowing slightly (as profit growth decelerates and margins are squeezed), it remains quite healthy.
Even the worst-case scenario – take 100 basis points from GDP growth for a US recession and then another 100 for a steep global downturn – would leave Chinese growth at 7-8% in 2008.
Beijing has said it will adopt a “tight” monetary policy, but all this really means in the current context is that the government will not attempt to reverse a macro slowdown. With net exports and firms’ profits already slowing and likely to slow further, it is difficult to envision why Beijing would want to take traditional tightening measures. After all, the leadership doesn’t believe the economy is overheated, and it must be worried about the impact of the ongoing slowdown of unemployment.
More interest rate hikes (part of efforts to raise the cost of capital to a rational level) and further increases in banks’ required reserve ratios (to maintain a high level of liquidity while preventing it from getting out of control) are to be expected but these measures will not qualify as tightening.
One reason for talking “tight” is to lower expectations for inflation. A second reason is to avoid the spike in investment that occurs every five years in the wake of the Communist Party Congress, as newly appointed local officials attempt to establish themselves via large construction projects. In the first quarter of 2003, for example, lending rose by 250% and fixed-asset investment nearly doubled.
Loan growth, which has been in its usual end-of-year slowdown, may be held down for a couple of months longer than normal to restrain local officials, but there is no reason to expect the government to crash credit flows when the economy is already slowing.
All bark, no bite
We can be fairly confident that the CPI will hold steady and then fall significantly in the second half of the year with pork prices falling as supply catches up with demand.
In recent weeks the government has begun to issue tough talk about food prices, threatening to intervene in the marketplace. My assessment of this stance is it’s all bark and no bite. Beijing wants to show that it is on top of the inflation problem and also to pressure food producers to think twice about raising prices.
In conclusion, the key issue for equity investors in China this year is margin squeeze.
CLSA’s purchasing manager’s index survey found in recent months that input price inflation hit a new series high, amid widespread reports of cost increases for fuel and general raw materials. Firms have raised their output prices for finished goods at faster rates, but the gap between input and output prices continues to widen.