China

I am waiting for just ONE article in the NZ media (or politicians) that will acknowledge this reality,

Global Economy: No rabbits hidden in China's hat this time

Investors will be looking to a data deluge from China this week to give the global economy a further lift after Friday's strong U.S. jobs report. They risk being disappointed.

Reuters,

5 August, 2012

Figures for July, starting on Thursday and covering everything from trade to bank loans and investment, are likely to show the world's second-largest economy is, at best, stabilizing rather than recovering briskly.

And while Beijing has both the will and the means to provide extra fiscal and monetary stimulus if growth flags, China-watchers rule out a repeat of the massive expansion of credit that successfully rebooted the economy after the global financial crash of late 2008.

That means China, and Asian economies increasingly tied to it, can do little to overcome the headwinds blowing in from the United States and, especially, Europe.

"The problems in Asia that are causing the slowdown come predominantly from outside the region," said Rob Subbaraman, chief economist for Asia at Nomura in Hong Kong. "Europe is a bigger than the U.S. as an export market for most Asian countries now, and it's a big investor in the region."

In today's interlocking global economy, Asia's travails are rebounding on the rest of the world. Siemens, Europe's biggest engineering conglomerate; BASF, the world's top chemicals maker; U.S. blue chip United Technologies; and Japan's Hitachi have all recently reported the impact of lower Chinese demand.

REBALANCING ACT

Asia as a whole wants to wean itself off exports and generate more domestic growth. China's current account surplus is just a third of what it was in 2007. The process, though, is generally slow.

"Over the next decade we will see domestic demand becoming a bigger engine of growth for China, and that will change the picture quite a lot for Asia," said Rajiv Biswas, chief Asia-Pacific economist for IHS Global Insight in Singapore.

"But we're not yet in a situation where the growth engine in Asia is strong enough to cruise through a recession in Europe and stagnant growth in the U.S.," he added.

China's economy expanded 7.6 percent from a year earlier in the second quarter, the slowest pace in three years. Economists expect growth to pick up moderately in coming months since Beijing has cut interest rates and is speeding up the approval of investment projects.

But this year has been remarkable so far for what has not happened in China: the ruling Communist Party has not gone flat out for growth despite the imperative to preserve economic and financial stability ahead of a once-in-a-decade leadership transition.

That is because the 2008 pump-priming has swapped one sort of dangerous imbalance for another: China's external surplus has shrunk, but the economy has become more dependent than ever on investment, which accounts for close to 50 percent of GDP. Personal consumption, by contrast, is no more than 35 percent of GDP, half that of the United States.

Beijing wants better-balanced growth and so, to the surprise of some, it has kept in place curbs to tamp down house prices. It has also kept local government investment on a fairly tight leash.

Seen in this light, the danger from this week's figures is not so much that growth undershoots but that, if it does, Beijing presses the panic button and puts investment spending back on the fast track.

"The risk is that you get more stimulus but it leads to a more unbalanced economy," Nomura's Subbaraman said.

As such, he said he would be paying particular attention to the relative strength of July's data on retail sales and fixed-asset investment.

Economists have been paring their full-year growth forecasts for China to 8 percent or less. Markets would react badly to a further slowdown, but Ting Lu, Bank of America Merrill Lynch's China economist, said even a 7 percent pace would not be bad given the weakness in the global economy.

"We expect China to achieve a growth soft-landing if the euro zone does not break up," Lu, who has an 8 percent forecast, said. "We see many risks, but the Chinese economy is still far from collapse."

SHIFTING DOWN A GEAR

Economists at Barclays Capital agreed that the overwhelming likelihood was recovery rather than relapse in China over the rest of the year as the government steps up efforts to support growth.

But they said financial markets needed to adjust their expectations to a China that grows at 8 percent a year and not the 10 percent average annual rate of the past three decades.

"Unlike post the 2008-09 crisis, China will not save the world. Political and economic constraints in China (as well as in the other economies) suggest there will be no silver bullet or panacea to quickly pull the global economy out of the doldrums, and 2012 will be a difficult year," they said in a report.

No outside central bank watches China more closely than the Reserve Bank of Australia, given the Australian economy's dependence on commodity exports to the Middle Kingdom.

In a quiet week for major central banks, the RBA is expected to leave interest rates unchanged at a policy meeting on Tuesday.

Citi expects some small upgrades to the RBA's economic forecasts when it released its quarterly monetary policy statement on Friday.

In Britain, by contrast, the Bank of England may well revise down its forecasts for growth and inflation in 2012 and 2013 when it publishes its latest inflation report on Wednesday, according to economists at Investec.

Warning: Most Chinese Companies Reporting Losses, Profit Declines

Chinese companies are warning they will be reporting either losses or declining profits for the first half. Corporate results are forcing stock markets down and pointing to a contraction in the country’s economy.

Gordon Chang

Forbes,

5 August, 2012

China Rongsheng Heavy Industries, China’s largest private shipbuilder, lost 19% of its value when it issued a profit warning at the end of last month. Yards in the country are in a terrible state—the industry’s orders for new vessels in May were half of what they were a year earlier—yet Rongsheng’s poor prospects had largely been discounted. The company’s shares tumbled not only because it hadn’t announced any shipbuilding orders this year but also because the U.S. Securities and Exchange Commission implicated Zhang Zhirong, its chairman and founder, in an insider trading scheme relating to the acquisition of Canada’s Nexen by CNOOC, a unit of one of China’s state oil giants.

We can perhaps dismiss Rongsheng as an aberration, but poor results at other companies are indicative of the state of the country’s increasingly troubled economy. Take China Cosco, for instance. The Hong Kong-listed subsidiary of China’s largest shipping company warned that its loss in the first six months of this year would widen to at least 4.14 billion yuan ($648.8 million). In the same period last year, the company was 2.76 billion yuan in the red. China Cosco posted a loss of 2.69 billion yuan in Q1.

Other enterprises, such as China Rare Earth, are also forecasting red ink. Data provider CapitalVue says that almost 900 China-listed firms are expecting losses or lower profits for the first six months of the year. Only 600 companies predict profit increases.

The list of companies forecasting profit declines is impressive. Air China, the nation’s flag carrier and the world’s second-largest airline by market value, has said profits will fall by more than 50%.

Huawei Technologies, China’s largest manufacturer of phone equipment, reported a 22% drop in H1 operating profit. The profits of Huawei’s rival, ZTE, fell by 12%. ZTE’s result appears suspicious because just two weeks before it had warned profits might fall as much as 80%. The company, when issuing its warning in the middle of last month, blamed “postponement of tenders” by Chinese network carriers and other reasons for a precipitous fall. Also not helping ZTE is China Telecom paying bills slowly.

Sany Heavy Industry, China’s biggest maker of excavators, lowered its annual unit-sales forecast to 10% growth from 40%. The company is apparently postponing a $2 billion share sale in the Hong Kong market due to a poor reception. “Many people think our industry will see a substantial decline, which I think is reasonable,” said Vice Chairman Xiang Wenbo in the middle of last month.

And for all the talk of China’s increasing consumption, profits are falling in the retail sector. Suning Appliance, the country’s largest electronics retailer, reported H1 profits were down 29.5%. Not surprisingly, Gome Electrical Appliances, the country’s second-largest, forecasts profits dropping by as much as 30%.

Problems are showing up across the board, even in Beijing’s favored businesses. The State-owned Assets Supervision and Administration Commission announced last month that profits dropped 16.4% in H1 for China’s biggest state-owned enterprises. The Commission said profits declined only 13.6% in Q1, so the falloff accelerated in Q2.

“We have seen more profit warnings than expected in the first half and there might be more than there were in 2008,” says Mao Sheng of Huawei Securities of Chengdu, the capital of southwestern Sichuan province.

Why are there so many profit warnings now? There is, according to the Wall Street Journal’s Tom Orlik, a “hypercyclicality” in profits caused by government-mandated “breakneck investment,” which resulted in “excess supply.” As Sany’s Xiang Wenbo noted, Beijing’s past stimulus efforts were “abnormal” and “irrational.”

China is coming off its stimulus sugar high, and so margins are under pressure. Profits, however, are just wonderful for companies in a few regulated industries, where Beijing essentially determines corporate results. One company reporting an outstanding number is Huaneng Power International. Profits were up 87.7% in the first half because the government raised tariffs 6.5% on December 1. Nonetheless, optimists should not take too much comfort from Huaneng’s H1 achievement. Why? The company announced that in the first half its output of electricity fell 1.46%.

The fall in Huaneng’s output is an indication the Chinese economy is tumbling. Eventually, however, Beijing’s newest round of stimulus measures will translate into better corporate results. UBS believes net income will rebound in Q4. That’s good news for China investors, but by then it will be too late to make up for the first three quarters.

And one more point. What Chinese companies tell the public is one thing; what they say in private is another. As Patrick Chovanec of Tsinghua University in Beijing notes, “Of the companies that I talk to throughout China, there isn’t a single one that is looking at an increase in revenues or an increase in profits this year.”

Why China's Growth Model Is Not Sustainable

Seeking Alpha,

4 August, 2012

China, which was once touted to be the global growth engine, is witnessing a significant economic downturn. The slowdown is not necessarily bad news for China, which grew at an average rate of 9.3% from 1989 until 2012. A sustained period of high growth leads to excesses in the economy and a subsequent slowdown helps in cleaning up the excesses.

However, the focus of this article is not on the current slowdown. This article investigates if the existing growth model for China is sustainable in the long term. Based on my research, I concluded that the current GDP growth strategy is unsustainable. Discussed below are some of the major reasons for this conclusion.

To take the story forward, presented are two charts. The first chart showcases China's new loans, while the second chart gives the GDP and GDP growth.

During 2000-08, average GDP growth for China was 10.4%. In terms of GDP by value, the GDP increased by 21.5 trillion Yuan (from 9.9 to 31.4 trillion Yuan). For the same period, 20.3 trillion Yuan of new loans were issued. The impact of debt on GDP growth was significant, with one Yuan of debt leading to an incremental impact of 1.05 Yuan on the GDP.

During 2009-11, average GDP growth was slightly lower at 9.6%. In terms of GDP by value, the GDP increased by 15.8 trillion Yuan (from 31.4 to 47.2 trillion Yuan). For this period, 25.7 trillion of new loans were issued. The impact of one Yuan of debt on incremental GDP growth was just 0.61 Yuan.

New loans are having a diminishing impact on GDP growth is the conclusion one can draw from the above data. This is important to understand, as China is trying to ease monetary policies again to boost growth. Given the kind of impact new loans are having on GDP growth, the policy action is bound to fail.

Instead of being productive, easy monetary policies and excess liquidity can manifest itself in the form of asset bubbles or consumer inflation. The real estate bubble in several cities in China serves as a good example of the point I am trying to make.

Talking about liquidity, China's M2 as a percentage of GDP for 2011 was 181%. The United States (with expansionary monetary policies) had a M2 as percent of GDP at 64% for 2011. Very clearly, the strategy of propping GDP growth through easy money is not sustainable with a skyrocketing M2. GDP growth is likely to collapse when inflation forces policymakers to tighten liquidity.

Further, rapid credit growth (significantly above GDP growth) always leads to a relatively high percentage of non-performing loans. There is a high probability of meaningful write-downs in the banking system in the foreseeable future. Credit growth can collapse as a result of this leading to further economic downturn.

In analyzing the sustainability of the current growth model, it is also important to look at the components contributing to GDP growth after the financial crisis. The chart gives the exports and industry value added as a percent of GDP.

 

After peaking out in 2006, exports and industry value added are on a gradual downtrend. With expectations of a prolonged phase of sluggish economic growth in the developed economies, exports as a percent of GDP will continue to decline. The same holds true for industry value added.

Therefore, exports contribution to GDP growth will continue to decline and needs to be offset by domestic consumption.

A comparison with other investment driven economies shows that China's gross capital formation as a percent of GDP is in uncharted territories and at unsustainable levels.

 

China already faces overcapacity in the manufacturing sector and adding further capacity will not benefit growth. Further, infrastructure development also needs to take place in a planned way. Constructing houses and roads can lead to a glut with actual urbanization happening at a relatively slower pace.

Given these factors, maintaining growth of above 8% would be a big challenge for China in the medium term. More importantly, consumption as a percentage of GDP is still below 30% and needs to increase over time.

Having talked about the concerns, I would like to add that China will continue to grow over the long term. The United States, during its rise as an economic power witnessed rough phases and even a depression. Similarly, in my opinion, China is in a period of economic consolidation after nearly 30 years of robust GDP growth.

How good or bad China does from here depends largely on the policymakers. It would be a mistake to intervene in the free economy and try to prop up growth. Instead, policymakers should allow the Chinese economy to slow down and get rid of its excesses.

From an investment perspective, depressed market and economic conditions gives an opportunity to investors to participate in the long-term growth story. Investors can consider exposure to the iShares FTSE/Xinhua China 25 Index (FXI), which gives investors an opportunity to have some large Chinese corporates in their portfolio.

At the same time, investors need to avoid currencies and equities of major commodity producers in the near term. China consumes over 45% of the world's iron, coal and steel. It also consumes nearly 40% of world copper. Over the long term, I remain bullish on industrial commodities.

In conclusion, there is no one formula or strategy to rebalance the Chinese economy. The best way would be to allow the economy to rebalance itself going through some pain in the medium term. It remains to be seen if policymakers in China are keen to prolong the pain.