China Report

Impact Of A Lower Growth Chinese Economy

By Dan Watson, China Correspondent, | January 19, 2012

After years of unprecedented growth, China’s economy is cooling off a bit.

Historically, the United States has been the primary engine for growth that has kept the global economy humming along at a comfortable pace. Given that, at least for the present, the United States can no longer be that engine, it’s important to look at what is happening inside the country that has become the shining light in an otherwise gloomy and dismal global economy (i.e. China). 

China has experienced a remarkable growth spurt over the past two decades such that today it is number two in the world and rapidly overtaking number one, (i.e. the U.S.). In the current, less than sparkling economy, China’s demand for imports could be critical to keeping the global economy afloat. However, after a couple of decades of greater than 10 percent growth the robust Chinese economy appears to be cooling off and slowing down a bit.

This “cooling off” is partly due to the overall poor health of the total global economy and in part due to China’s need to curb inflation. The effort by the Chinese to bring its economy under control continues to be a delicate balancing act. Too much pressure to slow down the economy could wipe out significant gains by the emerging middle class in China and seriously impact on China’s export ability.

Although China is attempting to redefine itself from a mostly export economy, it isn’t at a point where exports are not important to its survival. Recent overtures by the U.S. Government to have China “revalue” its currency have been met with less than enthusiastic response by the Chinese. In fact, the Chinese had been allowing a gradual appreciation of their currency. The Chinese Yuan exchange rate appreciated 4.27 percent against the US Dollar during the last 12 months. Historically, from 1981 until 2011 the USDYuan exchange averaged 7.03 reaching an historical high of 8.73 in January of 1994 and a record low of 1.53 in January of 1981. 

The Yuan revaluation process was largely undertaken in order to counter inflation, which had risen to dangerous levels. By allowing the Chinese currency to rise in value, import prices were suppressed somewhat, thereby mitigating the need for a rise in domestic prices. 

In addition, this revaluation action allowed the central bank to not have to print more money in order for China to purchase needed foreign currency. In essence, gradual appreciation became a legitimate anti-inflationary policy at a time when China’s inflation appeared to be out of control. Fortunately for the Chinese that is no longer the situation.

The overall inflation rate in China appears to be in a steady decline. Inflation appears to have peaked, given that it declined from 6.8 percent in July to 6.5 percent in August and 6.1 percent in September. While this level of inflation is still too high for comfort, the Chinese authorities appear confident that inflation will continue to decline.

The reason for their belief is due in part to the impact of the slowdown in the global economy and China’s own monetary policies that were put into place to fight rising inflation. In fact, there has been a noticeable reduction in China’s export growth. This decline in exports has contributed to slowing the growth of the Chinese economy. This decline in exports is attributable to the overall decline in the global economy and also to the rise in the value of the Chinese currency.

Behind the scene and less obvious to the outside observer is the impact on export prices that comes from increases in worker wages and infrastructure cost. As manufacturing costs go up along with the value of the Yuan, China exports become less attractive in the global marketplace. It’s not likely that wages or infrastructure cost will decline so the authorities have decided to curtail its effort to allow the Yuan to revalue.

Failure to back off from those actions that slow down the economy could cause the economy to slow down much more than desired. It must be remembered that the unemployment level inside China is estimated at approximately 30 million. A significant slowdown in the Chinese economy would add millions more to this number and possibly throw the country into a genuine recession. For certain, higher unemployment rates could lead to increased civil unrest.

Since China is the primary country that is driving the global economy it’s important for those who may be contemplating investing in China to understand the overall health of that economy. Normally, to judge the health of any country’s economy it’s important to look at five very important variables: Unemployment Rate; Inflation Rate; CPI-Consumer Price Index; GDP-Gross Domestic Product Growth Rate; and Balance of Trade). Obviously, there are many other important financial indicators but these five usually provide the observer with a reasonable picture of how things are going.

I. Unemployment Rate

The nonfarm unemployment rate in China was last reported at 4.1 percent in the first quarter of 2011. Historically (i.e., 2002 until 2010), China’s Unemployment Rate averaged approximately 4.15 percent. It reached a historical high of 4.30 percent in December of 2003 and a record low of 3.90 percent in September of 2002. Like the U.S. data, the real number of employed (listed as 30 million by the authorities) is probably much higher since a large number of unemployed Chinese, like their U.S. counterparts, have simply given up trying to find jobs. Some put the true number of unemployed Chinese at close to 35-38 million.

II. Inflation Rate

Unfortunately, similar to calculating unemployment rates there are numerous methods used to measure Inflation. Normally, inflation rate refers to a general rise in prices measured against a normal level of purchasing power. The most common used measures of inflation are: (a) the CPI, which measures Consumer Price Index; (b) the GDP (Gross Domestic Product) deflator, which measures inflation in the whole of the domestic economy. The inflation rate in China for September of 2011 was reported to be 6.1 percent, down from 6.5 percent in August and 6.8 percent in July. Over the past couple of decades China’s inflation rate has varied from -2.2 percent in March of 1999 to 27.7 percent in October of 1994. Over the past sixteen years the inflation rate in China has averaged around 4.25 percent.

III. Consumer Price Index

China authorities report that consumer prices rose 6.1 percent in September, down from August’s 6.2 percent but well above the government’s predicted target of four percent for the year. Food price inflation held steady at August’s level of 13.4 percent. During most of 2011 persistent high inflation has impacted consumer prices despite government moves to rein in soaring food and housing prices, which officials feared could cause social unrest as more and more citizens grow angry at higher costs for basic staples. According to government statistics, the September price rises were driven by a 40-plus percent jump in the price of pork, a 14 percent increase for eggs and 12 percent increase for grain. Food prices are of particular concern, as they affect the daily lives of everyone in the country, with foodstuffs accounting for more than one-third of the monthly spending of the average Chinese consumer. Owing to almost a year of higher than expected inflation the Chinese worker has been able to secure increases in their wages but not enough to keep them on par with rising prices. Look for more pressure on wage increases coming from workers if inflation continues at its current level.

IV. China’s GDP Growth Rate

In the third quarter of 2011 China’s gross domestic product GDP) expanding at the slowest pace in nearly two years. GDP growth moderated to 9.1 percent in the third quarter from 9.5 percent in the second quarter.  Although this GDP level is lower than in past quarters it is significantly higher than what has been achieved by the U.S. or European countries during the same time period. If we look at this number from a seasonally adjusted, quarter-on-quarter basis, GDP rose 2.3 percent following a revised 2.4 percent gain the second quarter. China’s economy is the second largest in the world after that of the United States. During the past 30 years China’s economy has slowly changed from a centrally planned system that was largely closed to international trade within the country to a more open market orientation that has a rapidly growing private sector. Even so, a major component supporting China’s rapid economic growth has been and continues to be “exports growth”.

V. China Trade Surplus

In August of 2011 China authorities reported a trade surplus equivalent to 14.5 Billion USD. As in the past, export growth continues to be a major component supporting China’s economic growth. Without a strong, vibrant export focus China’s economy would collapse overnight. For China, exports of goods and services constitute 39.7 percent of GDP. Government data indicates that China’s major exports for 2011 have been office machines, data processing equipment, telecommunications equipment, electrical machinery, and apparel and clothing. China imports mainly commodities such as iron and steel, oil and mineral fuels; machinery and equipment, plastics, optical and medical equipment and organic chemicals. Its main trading partners are the European Union, United States, Japan, Hong Kong and South Korea. China has developed a significant auto industry, which for the most part has focused on internal demand. With the advances in “all electric vehicles” it is likely that China will use its formidable export expertise to pursue markets around the globe.

Bottom Line

Although China is experiencing a bit of a slowdown and inflationary pressures on its economy it still offers more growth potential for most businesses than other countries in Asia Pacific or Europe and the United States. However, for the “new comer” to China, expect to find higher than expected labor, raw material and general infrastructure costs along with increased competition from both international and local companies. 

In essence, the risk associated with doing business in China is somewhat higher today than encountered by earlier entrants. This is due in part to the emergence of a huge internal demand for consumer goods fueled by a growing middle class as opposed to a somewhat insulated economy based mostly on exports. 

In addition local Chinese-owned and operated companies are much more sophisticated and offer significant competition as compared to the past. China is no longer an emerging or developing economy it is rapidly assuming its role as a true global leader.

Although labor rates are still lower in China than most other countries that picture is changing daily and is often offset by the cost of other manufacturing elements. The companies that will be successful in China today are those that have done their due diligence well, understand the true risk of doing business in China, have established clear routes to market access and offer new or unique technology/products and are prepared to assume the risk of doing business in China for the long-term.

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