Fears over a China crisis remain, but on balance the workshop of the world should keep delivering says Ewen Cameron Watt, chief investment strategist, BlackRock Investment Institute
China matters – a lot. The country has rapidly become the second-largest economy in the world. It will likely contribute two-fifths to global growth this year, twice as much as the USA. China is a huge influence on the world’s commodities markets and is the largest foreign holder of US Treasuries. GDP per capita leapt more than 20 times to US$4,400 between 1980 and 2010.
Ports, bridges, airports, expressways and entire cities have been built in record time. China is now the largest market in the world for cars, computers, mobile phones – the list is endless. Wine sales have more than tripled in just five years.
But the big questions now are how the current government will navigate the domestic property slump and the global economic slowdown, and whether the future leaders will be able to solve a ticking debt time bomb and deliver on promises to rebalance the economy toward consumption and sustainable growth. It has become clear China’s old playbook of “invest and grow” no longer works so well.
Real reforms to rebalance China’s economy are on hold this year because of the leadership change and an imminent collapse is unlikely, we think. The current leadership will not go out with a bang, but certainly does not want a train wreck during the final stages of stewardship. Property prices, sales and construction are important issues.
Politically sensitive food inflation is another one, as are manufacturing gauges such as the various purchasing manager indexes (PMIs).
We are optimistic about China’s economic trajectory in the short term, but a nagging worry is that markets already factor in a “soft landing” this year, leaving potential downside risk. At the start of 2012, the data were both conflicting and skewed by the effects of the early lunar New Year holiday. Property and key consumption indicators pointed down, while other gauges pointed up. For example, sales of heavy machinery used in construction, such as excavators, crashed and auto sales flattened, pointing to a general slowing in the wider economy.
By contrast, transport volumes are strong and a gauge of small business activity has been ticking up. This is important because small businesses employ 60 per cent of China’s workers and make up 90 per cent of companies. The rebound could indicate the government’s easing policy on liquidity has started to work. Bank credit enabled large companies to pay their supplier bills. Secondly, it could mean the bottom has not fallen out of exports because many small companies are exporters.
The key factors driving China’s economy have implications for investors. Examining the financial system, the deflating property bubble, the tricky shift to a consumption economy, politics and competitiveness bring five key findings.
Firstly, an explosion in credit growth resulting from Beijing’s 2009 stimulus has made the financial sector the economy’s Achilles heel and its biggest long-term threat.
The country can pave over problems this year, but the bills will come due. Secondly, the property slump is the biggest threat to economic growth and confidence this year. The sector is interwoven with the entire economy and has been a key growth driver. A government-engineered slowdown has brought down prices to more affordable levels, but has also created ghost cities.
Thirdly, China’s economic miracle was built on an undervalued currency, lots of investment, and subsidised energy and credit for manufacturers. Domestic savers financed China Inc.’s master plan by accepting savings rates below inflation, wage increases that lagged economic growth and a minimal social safety net.
Penultimately, China’s new leadership could take the tough measures needed to engineer a shiftÑliberalising interest rates, opening capital markets, market pricing of resources, and building out social services. But Beijing is not almighty. Local governments tend to go their own way and a desire for consensus has often resulted in political paralysis.
Finally, real wage growth, rising materials costs and environmental restrictions are changing the workshop of the worldÑfor the better. Some labour-intensive industries are moving elsewhere and automation is increasing. There is room for more productivity growth even as the easy gains have been harvested. Protection of intellectual property is still weak and global brands have yet to emerge, but we believe chances are China will remain competitive and confound the doomsayers.