China is one of the biggest mysteries for investors and economists with most data emanating from China rated suspect even by the Chinese leaders themselves. Therefore people are equally divided in saying that China will grow at the same double digit rates while others predict a massive crash. The more knowledgeable analysts like Michael Pettis have forecasted a dramatic slowdown in economic growth though not a crash. China’s economy is definitely going to slow down and GWI had given a number of reasons for the slowing down in a 2 year old post. Most of the reasons still hold validity.
- Real Estate is a Bubble - The Chinese real estate is in a bubble with real estate prices growing far in excess of Chinese income levels. Though the real estate is not driven by a debt fueled boom like the US and other developed countries, nonetheless average real estate prices/ average income levels would suggest that the real estate prices are poised to come down sharply. Chinese authorities are using both monetary and non-monetary tools to bring sanity to this market.
- US and European Export markets are slowing down – China’s growth has been export driven, like those of other Asian Tigers. However its main export markets of Europe and US are going to see sub-par growth in the next few years due to a debt driven excess. Europe’s Austerity measures and a low Euro is not an ideal situation for China’s export industries.
- Pressures on Yuan growing – China is facing an ever increasing chorus from countries around the world to appreciate the yuan which is artificially suppressed through currency controls. Some think tanks suggest that the yuan is 40% undervalued to its fair value against the dollar. With countries seeing their domestic markets shrink, everyone wants to export more and import less to repower their economies. An undervalued yuan is a trigger for trade wars.
- Foreign MNCs feeling discriminated against – China’s protectionist policies has led to an alienation amongst the foreign companies doing business in the country. Rio Tinto’s much publicized China corruption case and the Google abandonment of China has brought this issue into the limelight. Foreign countries are re-evaluating whether China’s huge market is worth the discrimination they face vis-a-vis domestic companies.
- Banks and Local Government have huge unaccounted liabilities - China’s corporate structure runs large based on patronage networks of government owned banks, state owned companies and provincial authorities. This frequently leads to misallocation in capital which shows up in the forms of NPAs. Local Governments compete with each other for projects giving out huge subsidies and incentives which are funded mainly through local land sales. With real estate prices crashing and profits of export industries being pressurized, this is another bubble that may crack.
- Chinese Stock Market is down the most among major markets in 2010 – The Chinese stock market has been the worst performer among major economies with the interest rate increases and real estate bubbles making investors wary. Note this by itself is a poor indicator of economic health as stock markets are generally poor predictors of economy in the short run.
- Chinese wages are going up – There has been a lot of social unrest and suicides in China as wages fail to keep in sync with the rising productivity. Suicides at Electronics Giant Foxconn and strikes at Honda are indicative of this trend. Low wages which are China’s biggest competitive advantages may no longer remain one for much longer.
Though China managed to avert a big slowdown during 2008 and 2009 through a massive injection of bank liquidity (most of which will result in NPAs), this time it looks unlikely. Already the industrial PMI is indicating a sharp slowdown falling to 9 month lows. Japan’s exports to China have also slowed down while there are anecdotal evidence of great distress amongst private businesses in China.
Despite slowing PMI, the industrial overcapacity in China still has a long way to go before it falls into balance. Huge oversupply fueled by negative real interest rates have led to dramatic overproduction and crashing prices. Solar Panels, Wind Turbines, Steel, Ship production are some of the sectors where companies have fallen into deep distress as revenues and margins have crashed due to price wars. With Europe slowing down and USA also facing the risk of recession due to the upcoming fiscal cliff, China’s export engine is unlikely to recover.
Chinese Green Companies are being forced to look at overseas market for Profits as their Domestic Market is being ravaged by fierce price wars. Wind, Solar and even Smart Grid Companies in China compete mainly on price as technology is not the strong point for these companies. Lots of these small companies are promoted through provincial government bodies with massive capital and other subsidies. With excess capacity and little technology, there is little incentive for consolidation in the Green Industry with the attrition the only way out. Even the bigger players like Goldwind, Suntech and Jinpan are facing huge pressure from these low margin, low cost small companies in China. The fierce competition in the domestic market has forced these companies to look at foreign market to generate revenues and profits. While the solar companies have succeeded in this endeavor capturing a massive 50% global marketshare, Wind and Smart Grid companies are still struggling to expand outside their home market of China.
Chinese PMI Plunge
The HSBC Flash China manufacturing purchasing managers index (PMI) fell to 47.8 in August, its lowest level since November, as new export orders slumped and inventories rose, a signal that a persistent slowdown in the world’s second-largest economy has extended deeper into the third quarter.
BlueScope Steel chief executive Paul O’Malley has issued a bleak warning for Australian iron ore and coking coal exporters, saying China’s steel capacity has already peaked, implying a slowdown is imminent for raw materials exporters.
Mr O’Malley told The Australian Financial Review yesterday that more Chinese steelmakers will be forced to follow BlueScope’s move to cut its output by half a year ago as the impact of crippling overcapacity continues to weigh on steel prices globally.
“My personal view is that China has already seen peak steel capacity,” Mr O’Malley said. “I think there is a significant overproduction of steel in China at the moment. And therefore to the extent that we’re at peak steel capacity in China at the moment you will see a slowdown.”
China had been on track to produce about 700 million tonnes of steel this year, but moves to wind back steel production and run down inventories have raised questions over whether volumes could actually decline on last year’s 683 million tonnes. More worryingly, official China Iron and Steel Association figures show the country had already built 850 million tonnes of capacity by the end of 2011, with expectations that this figure could rise to more than 900 million tonnes by the end of this year.