China’s December trade surplus of US$11.08bn was the largest on record… [signaling] both continuing high export growth [and] a decline in import growth. Several other critical parameters indicative of overall future economic growth have trended downward significantly since mid-year 2004, including fixed asset investment, domestic credit to the non-financial sector, and utilized FDI. In our view, [these] point to an economic slowdown to 2002 growth levels of real GDP at 8.0%. Fixed asset investment growth peaked in January/February 2004 at 53% YoY and posted a sharp decline to 30% levels starting in May [with the] administrative cooling measures… in mid-April. Slower investment growth is reflected in slower import growth since April/May, in particular in the area of investment goods (machinery & equipment) and… the slowdown was also evident in steel and non-ferrous metals as, for example, the growth of passenger car production slowed to 12% from 85% in 2003 and sales growth sank into the single digits in June and thereafter. The growth slowdown is… affecting real output – a fact underlined by the growth decline in electricity production in 2Q and 3Q 2004 from above 16% to 13%.
Total 2004 utilized FDI was $60.63 billion, an all-time high. However, investment inflows peaked in June and were at their lowest in the final quarter of the year [reflecting] the crackdown on select types of investment projects earlier in the year. Similarly, growth of credit extension to the non-financial sector slowed sharply from 20% plus levels in 1Q 2004 to around 11% in 3Q and 4Q 2004. M2 growth came down from 19.12% in April to 14.60% in December 2004.
Export growth has not been affected by the cooling measures, [amounting] to over 30% of GDP (31% in 2003), and drives China’s overall growth performance. Naturally, continued investment in new production capacities will be required to sustain high export growth and we believe [current levels] should suffice.
As such, overall growth reduction from above 9% GDP growth to the 8% level realized in 2002 prior to the 2003/2004 over-investment/ overheating episode is, in our view, exchange-rate neutral – i.e., it speaks neither for nor against CNY revaluation.
China’s principal growth risk, in our view, derives from the gross inadequacies of the financial system. For lack of any other significant investment opportunities (the undercapitalized stock markets are not for the fainthearted), Chinese households and corporations park their massive savings (CNY24.1trn as at December 2004 or 205% of 2003 GDP) in a shaky banking system saddled with nonperforming loans in the 35%-40% range of loan totals. As the economy slows and bank lending continues to be restricted by administrative decree, the risks to the financial system inevitably grow. China has deployed US$45 billion in foreign reserves to recapitalize two out of the four main state banks, and another US$35bn-US$50bn is likely to be pumped into one-third of the state banks in the near future. We believe China’s large foreign reserve accumulation (US$610bn at year-end 2004) provides for a sizeable cushion against any banking crisis. However policymakers are walking a tightrope as they slow the economy and simultaneously attempt to put the banking system on a sounder footing.
Industry view/ McKinsey & Co asks, Can China compete in IT services? China’s spectacular economic success has prompted speculation that the country’s software-outsourcing industry could soon compete with India’s. A recent McKinsey study of China’s software sector, however, shows that it will be many years before the country poses a threat. For starters, the Chinese must consolidate their highly fragmented industry to gain the size and expertise needed to capture large international projects. Currently, there is little movement in this direction.
The number of engineering graduates and software-applications professionals has grown considerably in recent years. Since 1997, annual revenues in software and IT services have risen by 42% a year, on average, reaching $6.8 billion [half India’s] in 2003.The number of English-speaking graduates in the workforce – particularly crucial in software outsourcing – has doubled since 2000, to more than 24 million in 2004.
But shortcomings in the structure of China’s IT industry prevent it from taking full advantage of these changes… Growth is driven by domestic demand – most customers are small and midsize Chinese enterprises that want their software customized to their own needs. Moreover, the country’s nascent foreign-software-outsourcing business accounts for just 10% of the industry’s total revenue, compared with around 70% for India. Japanese customers, which seek mostly low-value application-development contracts rather than more lucrative ones for design, supply about 65% of this sector’s income. And despite lower costs, operating margins in Chinese software-services companies average only 7%, compared with 11% at similar companies around the world, because many projects are below optimal scale….
To compete in global outsourcing, China’s software industry must consolidate. The top 10 IT-services companies have only about a 20% share of the market, compared with the 45% commanded by India’s top ten. Furthermore, China has about 8,000 software-services providers, and almost three-quarters of them have fewer than 50 employees. No company has emerged from this crowded pack; indeed, only five have more than 2,000 employees. India, on the other hand, has fewer than 3,000 software-services companies. Of these, at least 15 have more than 2,000 workers, and some… including Infosys Technologies, Tata Consultancy Services, and Wipro Technologies… have garnered international recognition and a global clientele
Industry View/ From KPMG, Advice on prospects in medical equipment In 2003, companies from the United States, Japan and Germany were the dominant exporters of medical equipment to China. Between 2000 and 2003, imports increased by over 90% – to US$2.2bn – 24% of the total market. Imports range from sophisticated imaging equipment to dental and generic supplies.
Foreign players dominate the top end with imports or locally produced equipment that use innovative technology. Domestic products occupy the lower end of the market.
China’s massive hospital network is poorly equipped. But the market for foreign companies is limited to the top quartile. There are over 67,000 hospitals nationwide. Of these, 75% are non-grade facilities, poorly equipped with fewer than 20 hospital beds in rural areas.
The market for imported [is] around 1,000 class III hospitals [biggest and best] and 5,500 class II hospitals [smaller but offering reasonable levels of care]. Class III hospitals tend to focus their investments on medical equipment imports [and enjoy zero tariff] – one Shanghai hospital spent around US$6m almost exclusively on imported devices in 2003.
As a competitive investment destination with low labor costs, multinationals are persuaded to move high-tech and high-value production to China. Many major medical equipment companies have invested heavily in setting up production facilities in China.
General Electric (GE) aims to make China its global production center for medical equipment. By 2005, local purchase and sales volumes are forecast to top US$600m. GE also established a US$26m industrial park for medical systems in Beijing in 2003, [and today it accounts for] one third of GE’s total global CT scanner equipment production.
Hitachi Medical Systems (Suzhou) Corp., a wholly owned subsidiary of Hitachi Medical, moved production from Japan to its Chinese subsidiary. It expects to increase locally produced equipment from around 50% to between 70% and 80% Toshiba Medical expects its medical equipment sales in China to hit US$500m by 2010, representing 10% of its global revenues.
Local producers with mid-range products and ties to hospitals are potential partners for foreign entrants. With its double-digit growth and aging population, China is attracting overseas medical equipment suppliers.
The domestic providers occupy the low-price end of the market, the multinationals the top tier. But it is the middle market, where the demand for quality goods [based on earlier technology] will provide most opportunity for foreign entrants. China looks set to pay dividends for early movers in this market.
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