The China factor amid a global crisis

China’s recent announcement that its growth rate had fallen below the magic 10% for the first time in over a decade this October confirmed what many economists had feared: the global credit crunch had begun impacting the world’s fastest growing emerging economy.

There was a raft of other clues that, at least on the export side of things, indicated all was not good for the dragon. Container shipments from China to North America as well as to Japan and Europe, China’s key markets, had each fallen from the month prior.

For the first time in more than 20 years, China will post a growth rate in its port-trade for the 2009 calendar year of less than 20%. There are signs elsewhere within China that the greatest GDP growth machine history has ever known is seizing up.

More than 90,000 companies in China have gone out of business so far this year. The vast majority of these companies were located in the Pearl River Delta located in Southeast China, where the heart of China’s manufacturing has been based since the early 80’s. There are also reports of major labor disputes over unpaid Chinese wages. In Shenzhen, at the beginning of November of this year, thousands protested after one factory was shut down, without notice, because of an empty order book.

The Chinese government has known for some time that its reliance on export-orientated growth is something it needs to shift away from.

Chinese officials have been talking for several years about helping Chinese enterprises migrate up the value-added tree. Government has even supported state and non-state enterprises in their research and development efforts. Even so, recent events mean China now needs to move faster than it was previously to address larger economic issues.

Like most major economies being impacted today, China’s banking institution has also cut its base interest rate, in October…down to 6.6%, although this is still high compared to the 1% in the United States, and 3% in the UK.

One very real problem has been the issue of numerous manufacturers and exporters receiving letters of credit (LOC) from banks to pay for their shipments.

Survey says

In a survey of 1,000 small and medium enterprises across Europe and North America this past summer, a ratio of 6:1 said they have been adversely effected by higher costs and tighter restrictions placed on them by banks. LOC were the oil that kept much of China’s export industry going…supplying credit and security.

With many costs in China now having tripled, and with no real alternatives, 90% of export trade relies on this LOC mechanism.

Reports of numerous foreign manufacturers looking at Vietnam and other geographies to develop lower cost manufacturing strategies, and in some cases, even shifting production back to their home countries, are common.

This year, consumer spending in China is up 23% year on year. This means, for the first time, signs are beginning to emerge of a real Chinese domestic market developing.

The Chinese middle class, at least, whose real income has risen this year, are not placing their money in low interest rate bank accounts (where the interest rate is a mere 2%) or, even in the Chinese stock exchange (which has lost 70% of its value this year). This group is also more wary about real estate property investments. Right now, the Chinese middle class is actually spending money.

Even so, China’s luxury goods market remains depressed. Furthermore, China’s 20 or so billionaires have each witnessed huge amounts of value wiped out from their portfolios. However, one of the most distressing issues for China’s central government this year is rural incomes which are down year on year.

There is already talk in many circles in China, and abroad, that China will be unable to meet its magic figure of 8% growth next year.

The announcement in early November this year by China’s central government of a massive fiscal stimulus package equal to almost US$600 billion displays just how concerned government is.The rapid disappearance of US and EU export markets is not a good thing for a country that relies so much on these export markets.

Meanwhile, China plans to build more roads, airports, and infrastructure to take up the slack.

A Chinese buffer?

Chinese government has one massive advantage in its favor. Government proportion of borrowing in China is one of the lowest in the world, amounting to only 22% of GDP. In the UK, by comparison, this figure is more than 45% and, in the US, it’s closer to 60%. In Japan (the island nation falling back into a recession it once thought it had managed to finally extricate itself from) it is a whopping 180%.

China sits on US$2 trillion of foreign exchange reserves, still increasing by about US$30 billion each month due to the trade deficit. And Chinese policy makers are confident that for China’s sheer size and relative capacity, foreign customers will simply not be able to source elsewhere. This commitment seems to have already been made.

Wal-Mart alone gets almost US$20 billion a year out of China. Tesco, the British-based international grocery and general merchandising retail chain, gets US$8 billion each year. Meanwhile, the toymaker Mattel sources 80% of all of the toys it manufactures globally in China. For this, Mattel relies on a supply chain of 10,000 Chinese companies.

What’s in store

The Chinese government knows it is in for a rough ride near-term, perhaps longer-term. Government also know a proper social security system must be build and, it must do something about public welfare.

By 2020, China will be one of the world’s fastest aging societies with two people of working age supporting one who has retired. China is also fighting a major gender imbalance, with 100 women currently to 106 men. In some areas of south China, the story is now already worse, with 145 men for every 100 women.

China must also do something about its massive underinvestment (relative to the nation’s size) in education and health care that has developed over the last few years. To make matters worse (for government) Chinese people have become much more vociferous in their discontent. The loss-making investments made by Chinese Investment Corporation in 2006 caused universal condemnation over the Internet, within China. Now, with almost 500 million Internet users in China, the Internet is becoming a formidable space for expressions of opposition.

China’s biggest challenge of all remains the environment. China’s reliance on fossil fuels has not changed. China remains a highly intensive consumer of energy. Those investing into China today might only find favorable conditions in the environmental protection sector. Everywhere else, investments will get ‘national treatment’ and take place across a level playing field.

Crisis or no crisis, the problems China faces today have each been approaching at a fast pace. All that has changed in the last few months is that these problems are now either already here or, their rate of approach has increased – and the need for the Chinese government to now make some bold steps, in concert with the international community, is even more urgent.

VentureOutsource.com, November 2008