China: Will It Survive The Global Downturn?

By Dan Watson, Contributing Write | October 24, 2013

China is currently the world’s second-largest economy, largest merchandise exporter, second-largest merchandise importer, second-largest destination of foreign direct investment (FDI), largest manufacturer, and largest holder of foreign exchange reserves.

Recently, there has been a great deal of discussion in the financial community about the continuing shaky state of the global economy.  In many of the current financial articles the status and role of the second largest economy (i.e., the Chinese economy) has been called into question.  We’ve seen a flurry of articles about China’s slowdown and whether the country has the ability to keep social order intact as things slow down.  During this “slow down” period we have seen inflation happening inside China, we have witnessed unemployment at levels never experienced by China.  We have seen an exit of wealthy Chinese who are escaping a China that has become polluted (air, water, land).  At the same time we have listened to various China experts and read numerous articles proclaiming that China will surpass the U.S. by 2016.  Polls taken inside China indicate that two out of three Chinese now predict that their country will overtake the U.S., an eight percentage point increase since 2008. The number of Americans today who agree has jumped 11 percentage points to 47 percent.

Let’s be honest, China has enjoyed an impressive run over the past three decades with real annual gross domestic product (GDP) growth averaging nearly 10 percent through 2012.  China is currently the world’s second-largest economy, largest merchandise exporter, second-largest merchandise importer, second-largest destination of foreign direct investment (FDI), largest manufacturer, and largest holder of foreign exchange reserves.  All of this sounds great but as the old saying goes, “all that glitters is not gold.”  China will also become the world’s largest importer of crude oil in October, surpassing the U.S. for the first time as the Asian giant’s rising consumer class of drivers grows increasingly thirsty for fuel, or so the U.S. Energy Information Administration is projecting.
China already is the largest importer of oil from the troubled Middle East, taking away a distinction that has plagued the U.S. since the 1970s. Its move to being the world’s largest importer, even as U.S. dependence on Middle Eastern oil declines to negligible levels, could transform regional and world politics as the focus of global defense efforts for decades has been keeping open the vital oil shipping lanes leading from the Persian Gulf to the US and Europe.

China’s emergence as the world’s biggest oil importer has been building for years, but grew particularly rapidly this decade along with record breaking car sales, which surged to more than 19 million units last year. China, with its increasingly prosperous population of 1.3 billion, has been the world’s largest market for autos since 2009.  Oddly, most Americans are completely unaware of this fact.
This number one distinction is causing China’s consumption of oil to surge by 13 percent to 11+ million barrels a day between 2011 and 2014. Additionally, China’s manufacturing industries are also heavy users of oil. With China’s domestic oil production pegged at about 3 million barrels a day and growing slowly, that means it has had to escalate oil imports to satisfy demand – a situation that is projected to continue for the remainder of this decade.

As it turns out, China’s growing oil need is directly affecting the U.S. and its consumers because it now has a major and growing influence on the price of oil and other critical commodities.

As you might expect, this remarkable economic growth over the past three decades by China has not been achieved without creating some serious internal financial and other problems along the way.  Pollution inside China is at a dangerous level.  Many of us recall the air pollution during the Olympics.  Almost daily there are reports of health related issues as a result of pollution sources.  The global economic crisis that began in 2008 has greatly affected China’s economy. China’s exports, imports, and FDI inflows declined, GDP growth slowed from its 10+ percent level to just over 7 percent, and millions of Chinese workers lost their jobs. The Chinese government immediately responded by implementing a $586 billion economic stimulus package, loosening monetary policies to increase bank lending, and providing various incentives to boost domestic consumption. The economy quickly bottomed out, and the rebound saw a quick recovery. The recovery not only sustained the Chinese economic miracle, but also sparked debate about the so called “China Model” among many economic theorists. They wondered what kind of system and cultural codes are hidden behind the myths of seemingly never-ending economic growth.

Unfortunately, what the world found out was that China had not discovered the secret to never ending economic growth.  As predicted by a number of global economists, a rapid decline began after the central government made a gradual reduction of the stimulus.  We saw a somewhat similar happening in the U.S. when the Federal Reserve announced a possible end to the QE program. The decline in China was in fact too rapid for the comfort of major policy makers. In the first quarter of 2012, Chinese macroeconomists proposed the policy of “steady growth.”

Historically, China has been reliant on a large export oriented economy (i.e., growth and stability relied mostly on income derived from exported products).  In recent years China has attempted to change their reliance on exports to become more of an internal, domestic consuming economy.  In attempting this transition, China has seen the evolution of a “Middle Class” which has driven numerous internal growth engines such as real estate, automotive production and infrastructure expansion.  Unfortunately, it also opened China up to a host of new problems, many of which they were not prepared to handle.  The new “Middle Class” found that they were able to generate and acquire wealth but had few ways to invest (i.e., they cannot invest outside of China and returns from local banks were very low).  In other words, the central government was more interested in exercising control than sponsoring more growth opportunities for the population.

Some years ago, the Chinese government changed its policy and allowed people to buy their own homes and with that change the flood gates opened.  In order to keep the fledging middle class resurgence alive and robust the Chinese government has spent over $2 trillion dollars to build whole cities for use by the Chinese public.  Unfortunately, with the downturn in the global economy, these cities have become “ghost cities” with no inhabitants.  Chinese officials have reigned in this problem regarding more construction and expansion but the vacant cities still exist. 

So, the question of the hour becomes, “what’s next”? Has the global downturn impacted China such that what we are seeing today is the new normal for China?

This is a very difficult question to answer.  According to a number of economist, the Chinese economy’s potential growth rate may have already moderated, from 10 percent in 2000–10 to an estimated 8 percent overall in 2010–20, and will slow further to 6 percent over 2020–30. If these figures are roughly correct, then the 7–8 percent range that we have witnessed over the past couple of years may have become the ‘new normal’ of Chinese growth.  Of course, this raises the question, can ordinary Chinese tolerate growth rates much below 7 percent? The same process that determines the impact of slower Chinese growth on the rest of the world will also determine how it will affect ordinary Chinese. Some economists speculate that the Chinese downturn will be similar to the Japanese downturn we witnessed some years ago.  In other words, the Chinese won’t mind a downturn in their GDP growth as long as the average Chinese has sufficient money to maintain a reasonable lifestyle.  I don’t’ subscribe to this theory due to the fact that even in the worst of the Japanese downturn the average Japanese was fairly wealthy.  In China, we still have a huge part of the population who are not benefiting from the growth that has occurred inside China. A downturn in Japan had a minor impact on the local population whereas a downturn in China will more than likely have a very serious impact on a large portion of the population. 

It would seem that for every theory you may have about China’s economy, if you look hard enough you will be able to find appropriate data to support it. Whether China will enjoy ongoing prosperity or be faced with an ever enlarging financial catastrophe I don’t pretend to know.  However, I do know that the current slowdown of GDP growth in China will have to have gut-wrenching effects at some point in the future.  There is no such thing as a free lunch in such matters.  If China leadership is smart (and a bit lucky) it may be possible to save China from experiencing a hard landing. Unfortunately, regardless of the path Chinas leadership chooses to take in this matter, somebody’s going to be hurt, eventually.

The impact of the slowdown in GDP growth on the coating industry is not known at this stage.  China has been enjoying a huge increase in the consumption of coatings over the past few years (see Fig. 1.0).  In 2012 this historical growth slowed to a total in 2012 of 11.5 million tons of coating. Projections for 2013 indicate only a modest change from 2012 level.

The Chinese coating market is highly diverse with the largest segment being architectural coatings (see Fig. 2.0). This breakdown of coatings may change in 2013 due to the economic slowdown directly impacting the housing market.
Speculation would suggest that with the actions taken by the Chinese leadership to curb the construction of more homes and cities that there will be a corresponding decline in architectural coatings. Although this may be a direct cause and affect happening there is still a huge “recoat” architectural market in China. 

On the surface, what appears to be continuing is the automotive coatings area. Whether or not the Chinese slowdown will impact on the automotive production area is yet to be decided. Different products that come under automotive paints include clearcoats and touch-up paints, pretreatment chemicals, intermediate coats, electrodeposition primers, and solid and metallic top coats. Automotive paints are required for metal, plastic exterior paint and for interior coating. Coatings that are used in auto paints include electrocoats, primers, powder coatings, basecoats, and clearcoats. Some of the major companies that deal in auto paints include DuPont, PPG, Nippon Paints, Kansai Nerolac Paints, BASF, AkzoNobel, KCC and Guangdong Yin Fan Chemistry Co. Ltd.  In other words, there is a huge investment by both foreign and local businesses inside China.

This author believes that the Chinese economy will eventually weather the current global downturn if its leaders choose wisely and implement true economic measures that are not just band aid fixes. There is reason to be concerned about China becoming the number one importer of foreign oil and what that might mean to the rest of the world.  For certain, the economic and social reforms that have started in China must continue if China is to survive long term and overtake the U.S. economy.  Until the bulk of its huge population enjoy the benefits of China’s remarkable growth over the past 30 years there is genuine concern about its long term stability.