Download economic insight GREATER CHINA Quarterly briefing Q3 2012 sloWdoWn oF china and

economic Insight
Greater China
Quarterly briefing Q3 2012
Slowdown of China and
the global economy reinforce
each other
Welcome to ICAEW’s Economic Insight: Greater
China, a quarterly forecast for the region prepared
directly for the finance profession. Produced by
Cebr, ICAEW’s partner and acknowledged experts
in global economic forecasting, it provides a unique
perspective on the prospects for China over the
coming years. In addition to Mainland China, we
also focus on the Hong Kong and Macau Special
Administrative Regions.
Since the last edition of this report, slow recovery from
the financial crisis has turned into backwards progress for
several important economies. The UK is mired in recession
and across the English Channel in Continental Europe
pessimism is spreading ever further. Spain may soon
request a bailout, Italy is stalling in its reform programme
and half the economies of the EU that reported growth
figures in the latest regional release showed an output
contraction in Q2 2012. The picture in the US is more
mixed, with a slow revival of residential construction
providing some hope. There too the economy has slowed
though, mirroring developments in industrialised and
developing economies from Japan to India to Brazil.
The global growth slowdown continues and China is
playing a key role in the process. Once heavily exportdependent, the country has long become a crucial
market for those countries it used to supply with
manufactured products. A slowing of Chinese growth
currently taking place thus contributes to a deceleration
in other countries as the one-way street of international
trade from developing Asia has become more akin to a
busy multi-lane highway.
BUSINESS WITH CONFIDENCE
icaew.com/economicinsight
Consumer spending on new cars, electronic items and
luxury goods is still holding up though and for many
Western firms China remains their most productive
source of growth. For now, other trading partners are
more exposed to weakening demand. Commodity
producers are seeing their terms of trade deteriorate as
the dragon economy develops indigestion in the wake
of its voracious appetite for raw materials. Falling mining
investment is likely to exacerbate the growth cycle for
many and remind global investors that big opportunities
are linked to big risks in emerging markets.
The effects of China’s slowing will, of course, depend on
the specific situation of each country – they are a varied
bunch. Given its size, the same can be said about China.
So will the slowing of the economy be felt the same way
across the country or are there regional differences? And
how will the government respond to macroeconomic
conditions at this sensitive time of political transition? In
this report we suggest some answers to these questions,
followed by a look at prospects for the next few years
and an evaluation of major risks facing the mainland,
Hong Kong and Macau.
Europe weighs on China, but Asia is more
important
The crisis in the eurozone has been identified as a major
contributory factor to the reduction in Chinese GDP
growth from 8.1% in Q1 2012 to 7.6% in the second
quarter. Further declines are expected as the eurozone
enters what will probably be an extended recession.
Figure 1 illustrates the situation, showing that sales of
goods to the EU fell by 16.2% year-on-year in July (from
$35.1bn to $29.4bn), setting up a further loss of export
markets in the third quarter. July 2011 marked the peak
level of exports and the decline is not adjusted for
inflation, so it’s even larger in real terms.
The graph doesn’t just reveal that Europe has been
a poor customer for China Inc., but also that the US
has overtaken the Old Continent in importance as a
trading partner this year. The EU had taken the top
export destination spot from the US in 2007, but that
was reversed this year and, given the dire medium-term
prospects of the eurozone, there is little prospect of
another swap back.
That contrasts with exports to Asia, which are still
performing strongly. The graph also highlights where
China’s priorities are increasingly shifting. A more
assertive foreign policy in the South China Sea, for
instance, is understandable given that this is also the
region where the country’s economic interests lie. As
an indication of the region’s growing economic clout,
China’s exports to other Asian economies have been
growing steadily since the post-crisis drop that ended
in early 2009. Emerging middle classes in ASEAN
and South Asia, as well as the unwavering rise of
industrialised nations such as Korea and Taiwan, point
to the durability of this trend. But even if the trend is
clear it is the deviations from it that tell the immediate
economic stories of our time.
icaew.com/economicinsight
cebr.com
Figure 1: Exports to Asia, the US and the EU, US$bn
100
90
80
70
60
50
40
30
20
10
0
2009
2010
US
2011
EU
2012
Asia
Source: General Administration of Customs of the People’s Republic of China
Industrialisation reaches remote provinces
Even if the share of China’s exports going to the
eurozone is dwindling, it still remains a crucial customer.
China’s economic model is shifting, but it hasn’t done
so overnight and the knock-on effect of falling exports
is visible in the performance of the country’s industries.
A fall in the growth rate of industrial value added, a
measure of output for companies making items from
socks to steel beams to iPads, has been raising concerns
about the growth trajectory. The annual growth rate for
June stood at 9.5%, down from the average of the past
decade of 14.8%, and fell further to 9.2% in July.
What sounds like a general reduction in output growth
across the country becomes a more nuanced picture
when looking at different parts of China. Industrialised
regions such as Shanghai, Guangdong and Beijing,
that have per capita income levels similar to those of
Western countries, have already slowed further than the
country average. Much of the country’s industrial base is
located here and they thus pull the average down. More
interestingly, output growth is strongest in some of the
least developed parts of the country. Tibet, for instance,
has had one of the lowest levels of industrial investment
over the past decade, but firms there are now adding
output at a rate that implies a doubling of industrial
output in less than four years if sustained. The western
parts of the country that include remote areas such as
Qinghai and Gansu are catching up.
The reason for this discrepancy lies in the labour market.
Wages are rising across the country as the annual flood
of migrant workers begins to flow less freely; instead
they are preferring to stay home or move less far away.
Firms are moving into the interior to take advantage of
lower wages, providing earnings opportunities closer
to home. In effect, Figure 2 illustrates that the eastern
seaboard is already linked in to the global value chain
and therefore responds sensitively to shifts in global
trade. Central and western areas are more akin to
developing countries where development is driven
by investment in production capacity aiming to take
advantage of cheap factors of production. Workers
remain in demand, but the following section looks at
a factor that may affect employment prospects over this
economic cycle.
economic insight – Gre ater Chin a
SEPTEMBER 2 012
Figure 2: Year-on-year growth in industrial value
added by region, June 2012
increases. In other words the investment boom taking
place is making China ever more dependent on itself.
%
25
Similarly to industrial production, at a regional level the
June rate of year-on-year growth in fixed asset investment
was much higher in less economically developed regions
than in the industrial heartlands. The pre-eminent cities
of Beijing and Shanghai – which already enjoy first-class
infrastructure and modern housing as well as relatively
modern production facilities – are reporting fixed asset
investment growth of about 5%, while industrial centre
Guangdong is fairly close at 9.1%. Again, remote parts
such as Tibet, Heilongjiang and Gansu are experiencing a
massive upgrading of their asset base. Even Xinjiang, which
holds great potential as a destination for the extractive
industries, is seeing fast growth even though its industrial
production grew below the national average in June.
10
5
0
Shanghai
Zhejiang
Guangdong
Hainan
Beijing
Xinjiang
Heilongjiang
Liaoning
Ningxia
Shandong
Hebei
Chongqing
Shaanxi
Shanxi
Tianjin
Henan
Qinghai
Jiangxi
Jiangsu
Jilin
Yunnan
Fujian
Guizhou
Sichuan
Gansu
Tibet
In. Mngla.
Hunan
Hubei
Anhui
Guangxi
-5
Industrial production, annual growth
Eastern Region
Country average
Central Region
Western Region
Source: National Bureau of Statistics of China
Slowing of new construction and bulk
trade raises fundamental growth concerns
Of the economy’s different sectors, construction is one
of the most labour intensive and by extension most crucial
for the labour market. The sector directly accounts for
about 12% of output but a range of associated industries
such as furniture, building materials and steel also depend
on it. In this context, a decline in new construction is a
worrying sign. For the first time since the financial crisis
fewer square metres of floor space were started in March
this year, with the pace of decline quickening to 9.8% by
July and heading further downwards.
Another signal of falling output comes from transport
figures. Road, air and sea transport growth was still in
positive territory in June – albeit with a declining trend
– but the volume of rail transport dipped to contraction
that month. Rail freight is especially efficient for heavy and
bulky goods such as raw materials and building materials,
adding to the conclusion that heavy industry and
construction are seeing output shrink. As with industrial
production, investment in buildings and other fixed assets
is coming down, but not in the same measure in all parts
of the country as the next section shows.
What we can conclude is that poorer parts are catching
up in terms of physical assets much as they’re seeing faster
wage growth and rising industrial production than the
better-off regions. Within continent-sized China theories
of economic development predicting a shift of capital
to less developed areas hold much more than they have
across countries. One take-away is that China’s economy
is not simply reliant on trade and wasteful investment
in capital-heavy areas. Instead, those living far from the
centres of progress are seeing growth trickle down and
continue history’s biggest improvement in human welfare.
Figure 4: Year-on-year growth in nominal fixed asset
investment by region, June 2012
%
35
30
25
20
15
10
5
0
Shanghai
Beijing
Guangdong
Jiangsu
In. Mongla.
Shandong
Chongqing
Sichuan
Anhui
Hunan
Hebei
Yunnan
Zhejiang
Henan
Shanxi
Tianjin
Guangxi
Tibet
Hainan
Hubei
Ningxia
Shaanxi
Liaoning
Jilin
Fujian
Heilongjiang
Qinghai
Jiangxi
Xinjiang
Gansu
Guizhou
20
15
Annual investment growth
Figure 3: Annual growth in floor space of new
construction and in rail freight volume
Eastern Region
%
80
Country average
Central Region
Western Region
Source: National Bureau of Statistics of China
70
Government set to step in as private sector
cuts back
60
50
40
30
20
10
0
-10
-20
2007
2008
2009
Rail freight
2010
2011
2012
New construction
Source: National Bureau of Statistics of China
Closer look at investment figures reveals
large regional differences
At a country level, China’s investment growth rate is
proceeding at a buoyant level of 20.9%. While this is
substantially lower than the 32.9% seen just three years
ago, it does further exacerbate the economy’s focus on
investment as a source of growth. As long as investment
grows faster than GDP its share in national output
icaew.com/economicinsight
cebr.com
The central government’s concern lies not just in
long-term development of the rural poor, but also in
the welfare of citizens in the urban centres. A belief
that material progress safeguards social stability via
employment creation makes it a priority for policy-makers
to keep up the rate of economic growth, whether that
compounds imbalances or not. With the world economy
slowing, China’s industrial production and fixed asset
investment on a downward path and rail and new
construction figures pointing towards trouble in the
real estate market, stimulus is highly likely. Both current
spending on goods and services as well as a boost of
state-financed investment are expected.
Figure 5 shows the expected trajectory of the two
government spending variables. For 2012 we expect a
boost of current public spending of 34% compared with
2011, followed in 2013 by another 26% increase to steer
the economy through the choppy waters of the global
economy. In 2014 we expect an easing of spending
economic insight – Gre ater Chin a
SEPTEMBER 2 012
growth to just 10%. In terms of public investment a boost
of 38% is expected, with much of it at the tail end of
the year since large-scale spending plans take time to be
implemented. Much of the stimulus is expected for 2013,
with a total increase of 27% in that year. As with current
spending a reduction of spending growth is expected for
fixed asset investment in 2014.
Figure 5: General government budget expenditure
and government spending of urban fixed asset
investment, CNY
%
80
70
60
50
40
30
20
10
0
Current spending
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
-20
2001
-10
Fixed asset investment
Source: National Bureau of Statistics of China
The huge boom of Macau gaming revenues is easing in
line with their giant neighbour’s economic expansion
since there appears to be a close link between corporate
profits of mainland firms and the money spent in the
territory’s casinos. Nevertheless, the economy grew
strongly in the first three months of the year and should
avoid a slump thanks to heavy construction activity,
abundant public resources and rising wages owing to full
employment. For this year we expect annual GDP growth
to come in at about 12.2%, followed by 11.6% next year.
A performance of 12.8% in 2014 reflects our assessment
of medium-term growth potential for the city state.
Figure 6: Greater China GDP growth forecasts
%
14
Business cycle won’t disrupt China’s quick
march to prosperity
In this section we weave together many of the threads
spun above by taking a view on their combined effect
on economic growth. Based on the trends identified, we
project GDP growth for the People’s Republic, Hong Kong
and Macau. The following and final section addresses the
main risks to our central forecast scenario, which are still
largely weighted on the downside.
Although things are slowing in Mainland China, the
expected rise in output over this and the next couple of
years is still astonishing. Rising wages that are exceeding
labour productivity are aiding consumption, helping to
shift the spoils of the country’s development from the
owners of capital to workers. A slump in some industries,
including construction and other capital-intensive
sectors, should limit the rise in industrial production to
some extent, but the growing technological prowess
of mainland firms promises a steady climb up the
value chain. The engagement with foreign companies,
especially the obligatory joint-venture structure of
strategic industries such as car making, has transferred
skills to native conglomerates that will increasingly insulate
China from the cut-price competition that it so excelled in
to reach its current state of development.
A fall in the growth rate of private sector capital
investment should be cushioned by a rise in public
spending of the central and local governments. Stateowned enterprises and the substantial clout of those with
a close affiliation to government should also support
investment, staving off a collapse of investment with
the help of loose lending policies in the banking sector.
In addition, strong government consumption spending
should further aid growth, meaning that growth is
forecast to come in at 7.6% this year as it stabilises at a
slightly lower level than in Q2 in the second part of the
year. For 2013 and 2014, further small reductions in the
growth rate to 7.5% and 7.4% respectively are projected.
This central scenario assumes that the global economy
keeps growing and a eurozone implosion is avoided.
icaew.com/economicinsight
While the mainland should do well on the back of its
domestic strength and extensive stimulus measures, the
Special Administrative Region (SAR) Hong Kong is more
exposed to the feeble state of major trading partners.
Being heavily export focused, its industrial sector took an
unexpectedly strong hit this year and GDP growth has
slowed to a trickle. The expected weakness of global trade
should limit the country’s output expansion to just 1.6%
this year, rising to 2.6% in 2013 as domestic consumption
rises and inflows of capital from the mainland boost the
economy.
cebr.com
12
10
8
6
4
2
0
China
2012
Hong Kong SAR
2013
Macau SAR
2014
Source: Cebr
Banking system will need further public
support
As has been widely discussed, China’s growth model
is too reliant on capital investment. With ‘diminishing
marginal returns’ – the tenth bridge isn’t as useful as the
first one – there is a risk of wasting funds on unproductive
projects. The higher the investment, the bigger this
risk, carrying with it the threat of being unable to repay
funds borrowed to finance the project in the first place.
If the hoped-for utilisation of securitised assets, such as
occupation rates for offices or throughput at a steel mill,
don’t materialise as anticipated in the financial projections
then trouble looms for the borrower. That situation is
compounded when investments are undertaken to satisfy
political targets and financial viability plays a minor role
from the outset, as is likely to happen in the coming
round of stimulus.
It is nearly certain that many projects will yield insufficient
returns to meet financial obligations. What initially affects
borrowers soon results in bank loans turning sour and
endangering the capital position of the banking sector.
In previous instances, the central government stepped in
with the establishment of specialised asset management
companies taking impaired loans off the banking sector’s
hands. Figure 6 illustrates the effects of this policy that
shifted the financial liability for bad debts from the private
economic insight – Gre ater Chin a
SEPTEMBER 2 012
to the public sector: the share of non-performing loans
(NPL) in the total number of loans has been steadily
coming down. It now stands at just 0.9%, an extremely
low level for a country at China’s stage of development.
There is only one way the NPL ratio can go from here:
up. Socialising the burden of bad debt has worked so far
because China’s debt to GDP ratio was low enough to
shoulder the burden, especially given the prospect of GDP
growth that will shrink the magnitude of the problem
over time. However, the expected spending surge, both
on direct investment and via looser lending in the private
sector, is growing the problem alongside the economy. As
the share of investment in GDP grows, which is expected
to happen over the next few years, the appetite to take
on bad debts should diminish as the size of the problem
grows beyond the capacity to gobble up problem loans.
Figure 7: Non-performing loans as a proportion of
bank loans
%
20
18
16
For now the banking sector is safe due to the state’s
capacity to bail it out, but that will not be the case forever.
The Chinese Government will have to find different ways
to stimulate the economy at difficult times. That will
include liberalising the financial system to make interest
rate policy more effective, a target towards which cautious
steps are being taken. Secondly a more pronounced up
and down of economic activity will have to be accepted.
The fear of social and political unrest in case of falling
incomes or fast-rising prices is real and points to the
need for a more open political system that is better able
to absorb social concerns. The development of a more
extensive social security system is another cornerstone
of a reform policy aimed at shifting towards a less statedependent economy.
The opening up of financial markets, steps towards a more
inclusive governance system, the gradual withdrawal of
state support for the private sector, and the establishment
of an effective welfare state in the context of a market
economy are tall orders. The current slowing of China’s
economy may put strains on the existing system and
expose the need for a new approach.
14
12
10
8
6
4
2
0
2004
2005
2006
2007
2008
2009
2010
2011
Source: China Banking Regulatory Commission
ICAEW
ICAEW is a professional membership organisation, supporting over 138,000 chartered
accountants around the world. Through our technical knowledge, skills and expertise,
we provide insight and leadership to the global accountancy and finance profession.
Our members provide financial knowledge and guidance based on the highest professional,
technical and ethical standards. We develop and support individuals, organisations and
communities to help them achieve long-term sustainable economic value.
Because of us, people can do business with confidence.
Cebr
Centre for Economics and Business Research is an independent consultancy with a reputation
for sound business advice based on thorough and insightful research. Since 1993, Cebr has
been at the forefront of business and public interest research. They provide analysis, forecasts
and strategic advice to major multinational companies, financial institutions, government
departments and trade bodies.
For enquiries or additional information, please contact:
Julia Jin
T +86 10 8518 8622
E [email protected]
icaew.com/economicinsight
cebr.com
economic insight – Gre ater Chin a
Sep tember 2 012
ICAEW Greater China
Room706, Tower E1, Oriental Plaza
No.1 East Chang An Avenue
Dong Cheng District
Beijing100738, China
icaew.com/china
ICAEW
Chartered Accountants’ Hall
Moorgate Place
London
EC2R 6EA UK
icaew.com
© ICAEW 2012 MKTPLN11607 09/12