A poorer China is bad news for everyone

GROWTH in China’s largest manufacturing firms has flatlined over the last three months and growth of small- and medium-sized manufacturing enterprises is contracting. The services sector is the largest contributor to gross domestic product and it too is facing slower growth, forcing China to consider opening the sector to foreign investment.

Earnings data in mainland China for last year reported a decline of 1.1 percent – the first decline since 2008. Aggregate net profit for non-financial companies declined 15.7 percent (driven by poor performance of state-owned oil companies).

Of the 34 listed steelmakers, 14 were profitable last year. Demand for steel is about 700 million tons a year, while production capacity exceeds 1.1 billion tons. The surplus is so large that on a per-kilogram basis, steel is cheaper than cabbage.

Facing a depressed global market, one of the few supporters of growth in the Chinese economy is $4.6 trillion (R72.5 trln) of household cash reserves built up over years of growth and a strong savings culture. Savings are turning into spending and retail consumption remains strong.

Facing uncertainty around the value of the yuan, poor performance in the stock market and strict capital controls that restrict Chinese investors from looking abroad, excess savings among households and businesses are being channelled towards property. But there is a catch – residents are allowed to own their houses but not the property that they are built on. All property is owned by the state and is leased through 20 to 70-year contracts.

Some of these contracts are reaching their expiry date and landowners are waking up to the harsh reality that their houses may not be as valuable as they expected. In 2007, changes were made to the law to require local governments to renew 70-year leases automatically, but it remains unclear what will happen to shorter leases or whether homeowners need to pay for the renewal. In a famous case in Wenzhou, a woman was made to pay one-third of the sales value of her house to keep it.

Decreasing savings, increasing consumerism, a rise in the purchase of depreciating assets and the decreasing security of property makes for a dangerous mix. It is a combination that shows uncomfortable familiarity with the run-up to the 2008 financial crisis in the US.

Increasing debt

The next stage of fragility will come with increasing debt when savings run out but consumerism continues to grow.

Economies can inflate on borrowed money but they cannot truly grow unless debt is paid back by increases in capacity and productivity. The invitation for foreign investors to join the services sector in China is a positive boost for short-term growth, but unless these foreign firms build China’s production capabilities, it will simply allow for surplus wealth to flow out of the country, running down net savings and capacity for investment.

A poorer China is not good news for anyone. China is the world’s largest goods trader and is responsible for more than 10 percent of the world’s total imports. It buys 8.7 percent of South Africa’s exports.

It is not just bilateral trade flows that are a concern. The slowdown in Chinese demand causes ripples of stagnancy across all export-based economies. This in turn causes currency depreciations, increased current account deficits and places pressure on government budgets.

The reaction of these emerging markets is often to bolster the shock with interventions in the currency value and stricter capital controls (or at least speak of them). Uncertainty causes doubt among foreign investors and portfolio traders and many hold off on injecting money into foreign economies when they need it the most.

The inter-connectedness of national economies has opened opportunities but has also led to unprecedented fragility and policies show a disconnect from what truly creates wealth in the hands of the people on the ground. China needs to get back to basics and focus on value-adding production rather than paper-based manipulations of the money markets.

The damage caused by the 2008 financial crisis is far from over and resilience can only be built by bottom-up real growth in the economy.