Saturday, January 31, 2009

No Bull in the China Shop

Madam Ren owns a tailoring shop minutes from the Bund in Puxi, Shanghai. Relocated over from a previous location about a year ago because the authorities were cleaning up the city ahead of the World Expo 2010, she estimates that business has dropped by 30% since the financial crisis struck hard in the third quarter of 2008. Operating out of a spartan shop in a textile complex, she specializes in making office wear such as jackets and long sleeves shirts for professionals. Business was brisk in the last few years and she concentrated on producing as fast as she could to satisfy her rapidly growing list of customers. She didn't even bother to sew on her own brand onto her creations. Foreigners, including Americans, Europeans and Singaporeans make up her client base as they find that forking up about RMB 100 per shirt is good value in their foreign currencies. These days, she finds that her regulars are coming back less often as the reality of the bearish global economy has hurt consumers' wallets.

Indeed, it is hard to be bullish about China's near term prospects these days. GDP growth in 2008 was 9%, down by the usual 12% experienced in previous years. Clearly the high octane growth engine has sputtered and economists are falling over themselves in dropping the 2009 estimate to the 6%-7% range. The number may still seem large for developed countries but for emerging China, growth in that range will signal a hard fall, not a soft landing for it is a floor figure to maintain social stability.

Well, we all have heard suggestions from watercooler talk that their official GDP numbers should be taken with a pinch of salt. Even putting that aside, the Chinese way of measuring GDP growth is strictly not comparable with other developed countries. China's quarterly GDP figure is derived on a yoy basis. In contrast, the US figure is determined on a qoq annualized basis. So whilst the headline 4Q08 figure of 6.8% may be decently comforting, converting this yoy figure to the qoq figure actually reveals a number that is zero or negative! So, China could technically be in a recession.

Skeptics of official figures point to other data which confirm our suspicion - the sharp fall in electricity production and the Purchasing Managers' Index which has remained below 50% for over five instances in 2008. Analysts expect the PMI to remain under 50% - firmly in contraction territory - for 1H09.

The severity and speed of the downturn has caught many by surprise and exposed the weakness in the structure of the Chinese economy. Dependent primarily on export growth and the property market, the retrenchment of demand from the US and Europe has hit China hard. As a result, manufacturers located in Pearl River delta such as Guangdong and Shenzhen as badly affected. This is news which have been flogged to death in major publications. What is less reported is that the malaise has also affected other coastal cities in the Yangtze River delta. In fact, container volume growth at Shanghai's port (China's busiest) was in negative territory for the first time ever in Dec 08. Hence, factories catered to producing goods for exporting have closed and plenty of migrant workers have returned to inner China way before the Spring Festival this year.

With key industries experiencing a sharp downturn, the problem is exacerbated by the fact that another six million new graduates are set to enter the workforce in 2009. The large number of graduates churned out annually has led to stagnating pay for new hires, about RMB2000-3000 per month for graduates from top varsities. With pay packages at financial institutions frozen and small businesses folding, the employer of choice is now the government sector. But such coveted positions are hard to come by and the government is mindful of possible unrest which may ensue if the restless and unemployed intellensia take to the streets. 20 years has passed since the Tiananmen incident but the memories remain fresh.

So, while the graduates are requested to seek employment further inland, it is unsure how the skillsets acquired through their education would be put to use in these largely agrarian cities. But the granting of loans to graduates to start their own business should help.

Unemployment and the structural composition of the economy are tough issues with no quick fixes. But there are many grounds for future optimism in the Middle Kingdom. The re-balancing of the economy towards domestic consumption will take time but China's has a strong balance sheet which it can tap to make the adjustments. It has an enviable FX reserves of US$1.9 trillion. Debt levels for households and the government is also very low by global standards.

The first RMB 4 trillion targeted primarily at infrastructure and construction spending was unveiled in October last year. Policies towards the property sector has also eased sharply through the course of the year by local governments. The latest to follow the Chongqing easing measures in mid January is Beijing. If the situation deteriorates further, the Chinese central government can and will do more. Why not do more to boost consumption directly via a second national stimulus package? The Chinese policymakers have been on the ball in recent months and we expect them to continue to be vigilant in the days ahead.

But investors should not expect instant results. The outcomes will not come overnight. Whilst the country's medium term prospects remain bright, more hard work is in store for China and entrepreneurs like Mdm Ren in the near term. She now works all through the week from 8.30am till 6pm. To boost sales, she may well have extend her operating hours, move up the value chain by creating her own brand or consider exporting her creations as well in order to benefit from the reduced value added tax under the stimulus package. For otherwise, she may well have to make do with much reduced sales for the immediate foreseeable future.



Anonymous Anonymous said...

if China don't make it through this crisis, no other country can.
The only worrying thing that could halt the inevitable rise of this giant is protectionism.
With talks of "buy American" in the air, Obama,hopefully,should turn a deaf ear to this cries.

11:17 PM  
Blogger Mr Market said...

Certainly, Anonymous @ 11.17pm.

Of all the various countries, China is probably the best placed. However, the objective of the piece was to point out that China will NOT have it plain sailing in the near term.

In Mandarin, there is a phrase: "jia jia you yi ben nan nian de jing", which is directly translated to mean: In every household, there is a scripture which is difficult to read. For all its positives, China does have issues it has to grapple with, from its economic structure to society widening income divide to possible civil unrest. Their current batch of policymakers are untested too so this challenge will be of paramount importance to them.

China has taken a defensive posture towards Tim Geithner's remarks that the factory of the world manipulates its RMB. We read it as the policy makers sizing up the Obama administration first rather than hitting back hard immediately. As for protectionism (buy and hire American), the world, including America, will not go anywhere if trade/labor barriers are erected. Globalisation and world trade will obviously dwindle.

It's a symbiotic relationship. America needs the world for cheap goods and resources as much as the world needs it. Going down the protectionism route will be plain foolish and may even hasten a decline in the American economy.

9:00 AM  

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