While China’s latest manufacturing release – a positive reading on its purchasing managers’ index – calmed some frazzled investor nerves Monday, it emphasized the significant role China's suddenly uncertain economy is playing in the fate of financial markets in the coming months. David Parkinson takes a closer look at some key factors in a Chinese slowdown – and where it might matter most for the markets.
A bright spot, but dimming
When we’re talking about a slowdown in China, it’s important to remember that this is only relative to the country’s high-octane expansion of recent years.
Year-over-year growth in China’s gross domestic product was 8.9 per cent in the last quarter of 2011, and is expected to dip to about 8 per cent for the first quarter. Most economists still see growth topping 8 per cent in 2012 and again in 2013. By contrast, total world GDP growth will be lucky to top 3 per cent, and developed economies could be well under 2 per cent.
Last month, China’s government lowered its official GDP growth target to 7.5 per cent from its previous long-standing target of 8 per cent – which would represent the slowest annual growth in the Chinese economy since 1990.
“China is likely to remain a bright spot [in the global economy] albeit not quite so luminescent as in the past,” concluded CIBC World Markets economist Peter Buchanan in a research report last week.
The housing hangover looms
The biggest risk facing China’s economy is probably a housing market meltdown – which, arguably, has the potential to rival the U.S. housing collapse of 2007-08.
Residential prices have fallen in most large and mid-sized Chinese cities for four months in a row, as the country increasingly feels the weight of a massive and growing glut in housing supply.
“Since early 2010, sales have increasingly under-paced building activity, creating an estimated eight-month inventory,” said Peter Hall, chief economist at Export Development Corp. “Market analysts expect total price declines in the 20- to 30-per-cent zone.”
That’s not quite as deep as the housing market collapse in the United States, where prices fell about 35 per cent. But the housing sector in China has become a much bigger economic engine, proportionately, than it was in the U.S. prior to the bust.
“The sector has accounted for 13 per cent of [Chinese]GDP recently, twice the U.S. level at the height of the boom five years ago,” CIBC’s Mr. Buchanan noted.
Exports take a European vacation
The biggest market for China’s export-driven economy is Europe, accounting for about 20 per cent of all Chinese exports. The euro zone’s deepening economic woes have put a substantial weight on China’s deteriorating trade balance.
China swung to its biggest monthly trade deficit on record in February, as exports tumbled for a second straight month. Looking at the first two months of 2012 – which helps adjust for the different timing of the Chinese lunar New Year holidays – year-over-year export growth has dropped off sharply from the end of last year. The culprit is almost entirely Europe – shipments there are down 1.1 per cent year-over-year.
And there’s evidence the slowdown may be far from over, said Brian Jackson, senior strategist for RBC Dominion Securities in Hong Kong.
“Growth in imports for processing trade (that is, components and raw materials that are imported as inputs for China’s exports) has slowed since the start of the year, suggesting that weakness in headline exports is likely to continue for at least the next few months.”
This isn’t your parents’ Chinese slowdown
The last time China had an economic “hard landing” was in 1989-90, when its annual growth slumped to just under 4 per cent. Experts note that the situation then is vastly different than it is now, in more ways than one.
Back in the late 1980s, Chinese inflation was running near 20 per cent annually. To tackle the problem, the government aggressively tightened monetary policy and slowed its market-oriented economic reforms, slamming the brakes on growth.
Today, inflation is not nearly the same threat. The most recent figure, for February, shows consumer prices rising just 3.2 per cent year-over-year, below China’s official 4-per-cent target. Even if inflation did move above the target and China were to tap on the brakes to quash inflationary pressures, the move wouldn’t be anywhere near as drastic as in 1989-90.
On the other hand, China’s increased role in the global economy in the past two decades means that even a modest slowdown could have a bigger global impact than the 1989-90 slump – especially in demand for commodities.
Shifting away from the commodity binge?
China accounts for roughly 40 per cent of the world’s demand for industrial metals, roughly 20 per cent of the world’s grain and 11 per cent of its oil. For most of these major commodities, the country is also the leading source for demand growth. Any hiccups in China’s growth pace would be a big deal to commodity markets – and to Canada’s stock market, with its nearly 50-per-cent weighting in resource stocks.
Analysts have suggested that the Chinese government’s new lower GDP target might reflect, at least in part, Beijing’s efforts to refocus its economic growth model from a massive (and commodity-intensive) infrastructure modernization to a more consumer-driven economy.
“A shift … to a more consumer-driven model – as many suggest is needed to sustain growth longer term – would not stall resource demand, but might mean a slower rate of increase than in the recent past,” Mr. Buchanan said.
By the Numbers
China's share of world GDP, 1990: 1.8%
China's share of world GDP, 2011: 11%
China's exports in February, month-over-month change: -24%
European Union's share of China’s total exports: 20.1%
Out of China's 70 biggest cities, number with rising new-home prices in February: 4
China's official manufacturing purchasing managers' index, March (over 50 equals expansion): 53.1
HSBC/Markit manufacturing purchasing managers' index for China, March (below 50 = contraction): 48.3
Sources: Bloomberg, European Commission, National Bureau of Statistics of China