How sick will SA get?

CHINA SNEEZES

Finweek English Edition - - FRONT PAGE - BY CIARAN RYAN

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.

COM­MOD­ITY CRASH

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.”

CUR­RENCY WOES

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

The Economist.

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.”

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