China’s downturn comes at a very difficult moment for Russia, which supplies a healthy percentage of China’s imported oil.Photoshot/Vostock Photo
China has cut its growth target for 2015 to 7%, the slowest expansion in over two decades. August Data shows it will be a stretch to hit even that. China is faring worse than many had expected. Its deceleration is a major reason for the sell-off of global commodities, from iron ore to coal, over the past two years. At a basic level, it was inevitable that the Chinese growth rates of the past three decades, which averaged 10% a year, would wane. The law of large numbers (financial, rather than statistical) applies to nations as well as to companies: the bigger an economy gets, the harder it is to keep growing at a fast clip.
Growth is a prime function of changes in labour, capital and productivity. When all three increase, as they did in China for over one and half decade, growth rates are superlative. But they are all slowing now. China’s working-age population peaked in 2012. Investment also looks to have topped out (at 49% of GDP, a level few countries have ever seen). Finally, China’s technological gap with rich countries is narrower than in the past, implying that productivity growth will reduce, too.
Taking advantage of easy credit that was part of the government’s post-financial crisis economic stimulus, manufacturing units created huge capacities resulting in a mismatch in demand and supply. With contraction in domestic demand, the gap has further increased and there is a huge inventory built by companies, which has blocked funds and added to the problem of banks.
The single most important development has been its credit binge. China's debt grew from USD 7 trillion to USD 28 trillion. Debt to GDP is approximated to be a whopping 250-300%. This puts China as one of the most indebted nations in the world. China's debt is roughly one third of global GDP, to put into context. This debt allowed China to power its economy through the global financial crisis but also saddled it with a heavy repayment burden.
Most worrying, much of the credit flowed to property developers. China’s inventory of unsold homes sits at a record high. The real-estate sector, which previously accounted for some 15% of economic growth, could face outright contraction. New property fell by nearly a third in the first eight months of 2015, compared with the same period a year earlier.
China's stock market enjoyed a spectacular rally until mid-June when it suffered an even more dramatic decline, slumping more than 30 percent over a three-week period. Between June 15 and August 27, 2015, the Shanghai Index fell about 40 percent. Authorities rolled out a range of measures to restore confidence but they had only a short-term impact. The rescue package included big investors being barred from selling their stakes, curbs on margin trading and restrictions on short-selling. The state-backed China Securities Finance Corp also stepped in to buy stocks on behalf of the government.
China’s downturn comes at a very difficult moment for Russia, which supplies a healthy percentage of China’s imported oil. According to latest figures from the Energy Information Administration (EIA), Russia supplies 15 percent of imported oil in China. Oil prices have plummeted from over US$100 a barrel this time last year to about US$45 this week. Falling demand from China makes near-term recovery unlikely and could pull prices down even further. With sanctions on Iran soon to be lifted, Saudi Arabia now faces a revitalized, oil-producing heavyweight regional rival. Russia must worry over the long-term impact of Western sanctions. For the past 20 years, these governments could count on Beijing’s unquenchable thirst for oil. That’s now in doubt.
The biggest economic impact tied to the China’s slowdown could well be outside of China, particularly among suppliers of the raw materials China has used to fuel its industrial and investment binge in recent years. China consumes roughly 47% of the world’s base metals, up from 13% in 2000, according to the IMF. Metal prices are now roughly 44% below their 2011 peak. The decline in consumption of steel in China, which accounts for over 57% of world consumption of iron ore, would hit Brazil badly as rough estimates suggest that every 1% increase in Chinese steel consumption translates into a 0.4% increase in the quantity of iron ore exported by Brazil. It is likely the slowdown in China will hurt iron ore exports from Brazil. The affect on India will be marginal, as India’s iron ore exports to China is low because of restrictions on mining. The impact would be visible on India’s export of cotton, copper and iron & steel, which could further lower India’s exports to China.
The lower metal prices could work to India’s advantage as it seeks to revive its own manufacturing sector and attract foreign companies to “Make in India”. China’s consumption boom in the 2000s attracted several multinationals to manufacture in that country for the domestic market. India could tread the same path if government succeeds in its efforts to make it easier to do business in India. However, India need to be watchful against dumping of products such as steel, tires and so on, where huge inventories have been built.
China still imports more than half the metals exported by Australia, Peru, and Indonesia and more than a third exported by Brazil and Chile. In fact, Australia (36 percent of its total exports to China), Chile (24 percent), Indonesia (13 percent), Brazil (19 percent) and South Africa (10 percent) were already exposed to China through their overall trade numbers. But it’s their deep dependence on commodities that puts them most at risk. 86 percent of South Africa’s exports to China are commodities-based, for Brazil it is 45 percent. Brazil’s soybean shipments are unlikely to suffer as much, due to the expected increase in available income among Chinese households.
China is South Africa’s largest trading partner since 2009. China is the second largest consumer of diamonds and also of gold and platinum. The slowdown will depress consumer sentiments which will result in lower sales of jewellery, affecting South Africa, a major exporter of diamonds, gold and platinum. This will impact the South African Rand which has depreciated significantly in 2015. India will benefit from the drop in global prices of precious metals which may push up its own jewellery exports and domestic sales.
China is Russia’s single largest trade partner, accounting for $30.6 billion of imports and exports in the first half of the year. That figure represents a 28.7 per cent fall from a year earlier, according to Russian customs data. The bilateral trade may go down further. India’s exports to China have already shown a decline of 20% in 2014-15, and the decline may further increase in 2015-16 due to the economic slowdown, and devaluation of the Yuan making imports costlier. The same is true for other BRICS members.
The shock devaluation of the Yuan has hit other emerging market economies, from Russia, South Africa, India to Brazil, whose exports are now comparatively more expensive, and there are fears of a round of copycat depreciations that could see a "currency war" break out.
The devaluation of Yuan will further increase China’s competitiveness in exports. While the Indian Rupee has also depreciated a little in last one month, it has not fallen as much as the Yuan, and can hit India’s exports, particularly in price sensitive segments. Russia, South Africa and Brazil, with massive depreciation of their currencies, still have a relative edge over China. While India and China have very few overlapping products in exports, yet competition can be seen in sectors such as apparel, leather, iron & steel, plastics, and organic chemicals.
China accounted for 6.1 percent of all foreign direct investment (FDI) in Russia in 2014 according to data from the Central Bank of Russia, a number that has risen as Russia has been isolated from Western capital markets and investors. In the heady days of early May, there was even talk of increasing official Chinese investment by 150 percent over the next 5 years. However, this goal now seems optimistic given the uncertain future of China’s own markets. Chinese investment in Russia fell 25 percent in the first half of 2015.
Indian stock markets could benefit. Chinese indices have run up in recent months although they corrected sharply earlier this week after restrictions on margin trading. Indian stocks, as a result, are reasonably valued and could find it easier to attract foreign institutional investor’s (FII’s) money. The slowdown of China coupled with increasing manufacturing cost provides great opportunity to India to attract FDI as it has huge consumer base. However the focus on infrastructure, ease of doing business and predictability in taxation would be a key to attract FDI.
Even well-diversified economies have something to lose from a Chinese slowdown. That’s because China, already the world’s second largest economy, has become crucial for global trade over the past two decades. In 2000, China accounted for just 3 percent of the global goods trade. By 2014, that number had jumped to 10 percent. China became the world’s lead trading nation in 2013. China by itself accounted for about 17 percent of the world’s overall GDP in 2014, but its demand for imports has already fallen 14.6 percent over the first seven months of 2015.
SC Ralhan is President, Federation of Indian Export Organisations (FIEO).
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