How sick will SA get?
In the last month the Shanghai Composite index, a proxy for the Chinese equity market, fell 30% after a 150% increase over the previous year.
That’s no train smash, but what is alarming is that it is the steepest drop in f ive years. The Chinese government’s commitment to market forces was put to its first real test and it blinked: bans were imposed on short-selling, initial public offerings and on equity selling by large investors. Up to a third of Chinese stocks are still restricted for purposes of selling.
The government has promised to support equity prices with hard cash, but rather than spreading calm, there is a sense of panic in these measures. The stock market could be just one of several bubbles ready to pop: two others ready to be taken to the knacker’s yard are real estate and so-called zombie manufacturing companies with negative cash f lows being kept alive on easy credit.
Apart from the trillions of dollars wiped out on the stock market, Goldman Sachs estimates some $225bn (R2.8tr) of capital f lowed out of China between April and June of this year.
It’s not as if the Chinese economy has stalled. It is still expected to achieve between 6% and 7% growth this year, according to official government forecasts, but this is a considerable slowdown for a racehorse shod for 10% annual growth. There is a real fear that China may have seen the last of its double-digit growth. The government long ago recognised the need to re-orientate its economy from export dependence to domestic consumption. It aimed to accomplish this by f looding the market with easy money to stimulate consumption among its 1.2bn people. The result is a debt bubble that needs yet more debt to stay af loat. Debt as a percentage of GDP has soared to 250%, according to Standard Chartered Bank, more than any other emerging market economy. In raw terms, debtto-GDP has doubled since 2008.
Consumption grew 10% l ast year, but only accounts for 40% of GDP. So this engine of growth is not enough to rescue it from the investment f light (investment in 2014 accounted for 50% of GDP). Even consumption appears to be under strain, as ref lected in steadily falling car sales in recent months.
For the rest of the world, slower Chinese growth translates into weaker demand for commodities: Brent crude oil is down by half to $54 a barrel since 2012, while tin, copper and iron ore are between 40% and 60% down from their peaks.
“Compounding matters is that most miners can’t afford to cut back on supply to try and prop up prices, so we may not yet have seen the bottom,” says Jason Muscat, senior industry analyst at FNB.
“This is obviously very bad news for South Africa as it means a material decrease i n export revenue and prevents a faster narrowing of the current account deficit. Fortunately for our economy, the lower oil price is reducing the i mport bill and offsetting what would otherwise have been a far worse deterioration in terms of trade. Even so, our expectations are for the current account deficit to narrow very slowly, which should keep the rand under pressure, raising inflation and interest rate concerns.”
The two sectors of our economy that are going to be hardest hit are mining and manufacturing, which are already on their knees with labour disruptions and electricity constraints.
“We are al ready seeing i ron ore, plat i num, gold, coa l a nd steel producers closing mines or production facilities, and this means job and wage losses, which will impact consumption,” says Muscat.
SA is not alone in feeling the effects of slowing Chinese growth. Austra li a , Canada a nd ot her commodity-based economies in Africa are also feeling pressure. The Trends Research Institute in the US offers this bleak assessment arising from China’s troubles: “China – in midst of an economic slowdown, an equity market calamity and trying to keep its real estate bubble from bursting – absorbs some 50% of copper, iron ore and coal exports. Thus, nations rich in commodity resources, such as Canada, Australia, Brazil, Venezuela, Peru, Russia, Nigeria, Angola, Chile and Indonesia, are in recession or heading into one as demand for their exports declines worldwide.”
For emerging market economies such as SA, weaker commodity export prices t ranslate i nto lower foreign exchange earnings, and ultimately weaker currencies. The rand is down 20% against the US dollar over the last year, the Brazilian real is down a third, the Malaysian ringgit 17% and the Indonesian rupiah 15%. Most emerging market currencies have dropped below levels last seen at the height of the 2008 financial crisis. That creates balance of payments stresses that may force some countries to seek bailouts from the International Monetary Fund (IMF).
Another dagger hanging over emerging markets is the prospect of an increase in the Federal Reserve lending rates later this year, which will prompt a f light of capital to the US and further weakness for emerging market currencies.
In a recent report Peter Schiff, president of Euro Pacific Capital, argues that China’s economy is fundamentally sound, but is being held back by a loose monetary policy that is designed to prop up the value of the US dollar and to suppress the value of its own currency, the yuan. It is in China’s interests to maintain a strong dollar to maximise earnings from its exports. The problem, says Schiff, is that this creates distortions and bubbles within the Chinese economy.
If the air continues wheezing out of the stock market, investors who bought shares on borrowed money will face margin calls from the banks. That imperils the housing market, which is where much of the country’s savings have ended up.
The r ea l- e s t ate s ec t or, which previously accounted for some 15% of economic growth, could face outright contraction. New property starts fell by nearly a fifth in the first two months of 2015, compared with the same period a year earlier, according to The Economist.
Chinese housing prices were already down 4.5% last year – the first decline in two decades – and the problem is only going to get worse. There is a fear the government will try to delay the inevitable with further cash injections into an increasingly slowing economy, which i s t he fa i l ed prescr i pt i on administered by Japan in the 1980s. A far better solution, according to Minxin Pei, senior fellow of the German Marshall Fund of the US, writing in Fortune magazine, is to let property prices fall and entice buyers back into the market.
Chinese factories are operating at about 70% capacit y, and t hose with negative cash f lows should be allowed to go to the wall rather than propping them up with credit. Michael Hasenstab, chief investment off icer of Templeton Global Macro, says in a recent report the slowdown in Chinese growth to about 7% aligns with the government’s own plans. He adds that the authorities recognise the slowdown as both unavoidable and healthy, and consistent with a rebalancing of China’s growth engines away from investment and toward consumption. Recently, however, signs of growth slowing below the government’s target have surfaced. This has triggered renewed warnings that the economy could soon suffer a hard landing, made inevitable by the imbalances and weaknesses accumulated in key sectors of the economy.
THE IMPACT ON SA
China’s slowdown has hurt the SA economy through lower commodity prices and a weaker rand. A report by Nomura points out that while SA initially benefitted from lower oil prices, this was offset by a slide in metals prices and larger oil imports required to keep Eskom generators going.
A softer landing for China would ease some of the commodity price pressures on SA. China became SA’s largest trading partner in 2009, and that position remains unchallenged. Twoway trade with China increased by 32% in 2013 to R270bn, according to Stats SA, but the balance of trade remains firmly weighted in China’s favour.
In 2013 t his def ic it amounted to R38bn. This trade imbalance is something that comes up in all bilateral meetings between the governments. In 2012 Distell acquired a majority share in a Chinese liquor distribution business, pointing the way for other companies seeking penetration of this market.
SA’s exports to China comprise mainly minerals, while imports from China are made up almost entirely of manufactured goods such as textiles, machiner y, f o ot wea r, c l ot h i ng, electronic equipment, appliances and foodstuff.
One SA sector devastated by Chinese competition is textiles and clothing. While Lesotho’s low-wage economy succeeded in picking up Chinese investment in clothing and textile factories, SA lost an estimated 70 000 jobs over the last eight years due mainly to Chinese competition. China exported an estimated $107bn of apparel in 2009, compared to just $2bn for sub-Saharan Africa, according to Justin Lin, former chief economist of the World Bank. Currently, South African steelmakers are urging government to impose i mport duties on cheap Chinese steel to protect local manufacturing capacity and jobs (see page 15).
Chinese i nve s t ment i n SA between 2003 and 2014 comprised 38 foreign direct investment projects representing a total capital investment of R13.33bn, according to statistics released last year by the department of trade and industry. During the period, a total of 10 992 jobs were created, it said.
Sectors covered by these i nvestments were metals, motor, communications, f inancial services, f ood a nd t obacco, c hemica l s , industrial machinery, construction, machinery and transportation.
Major investors include Sinosteel a s wel l a s t he I ndust ri a l a nd Commercial Bank of China (ICBC), which bought a 20% stake for $5.5bn in Standard Bank in 2007.
Earlier this year, Chinese f irm
Shanghai Zendai began construction on th e R8 4 b n de v e l o p ment i n Modde rf o n t e i n , ea s t e r n Johannesburg. This project will last 20 years and eventually include 35 000 housing units, forming the core of what the developers claim will be the “New York of Africa”. It will create a reported 100 000 jobs. Chinese companies have also invested in SA’s mining, cement, transport and power sectors. The bulk of Chinese companies investing in SA are state-owned and focused on resources, with China as t he customer for the product output.
UPSIDE TO AFRICA
There is a potential upside to China’s slowdown, according to Martyn Davies, CEO of Frontier Advisory. China has started to move some of its manufacturing capacity offshore to lower-cost economies, away from t he i ndustr y-heav y southeast of the country. Africa is in a position to pick up some of this economic rebalancing – if it makes itself more welcoming to investment in lowcost industries. “If this opportunity is seized by progressively reformist African states, they could well be on the cusp of a 19th-century style industrial revolution – generating jobs and creating new industries,” Davies says.
An example of this is already unfolding in Ethiopia. The sovereign wea lt h f u nded China Afr ic a Development Fund is f inancing a special economic zone industrial park to t he value of $ 2bn over the next decade to create a l ight manufacturing zone on the outskirts of the capital city Addis Ababa. The focus is footwear and clothing. The eventual outcome of this could be the creation of 200 000 jobs, according to
Says Davies: “China’s recent commercial activity on the continent could be divided into t wo simple categories – la r ge state- owned enterprise (SOE) investment alongside Chinese micro-enterprises owned by entrepreneurial migrants either trading or selling. A new type of Chinese firm will be coming to the continent over the medium term – growing private firms that best represent the real competitiveness emanating from the Chinese economy. “While resources have underpinned China’s foray into Africa, a shift is beginning to occur – no longer planned by the government in Beijing but shaped by the market. The potential move of manufacturing out of China to Africa is the next thrust.”