Morgan Stanley's Stephen Roach believes the world should prepare for the increasing possibility of a meaningful slowdown of the Chinese economy. Here are the key points from Roach's May 23rd piece entitled "What if China Slows?":
- Supply-side numbers remain strong.
- Re-acceleration of industrial output growth to 16.0% year-over-year (y-o-y) in April 2005.
- Chinese GDP growth trajectory held at 9.5% in Q1 2005.
- Momentum continues to be driven by surging Chinese exports.
- Industrial output for exports estimated to have risen 29.9% y-o-y in April.
- Chinese exports grew 32% y-o-y in April.
- Fixed investment grew 26% this year through April.
- While fixed investment growth is lower than the 40% comparisons of a year ago, they exceed the government’s official 16% growth target for the sector.
- Fixed investment sector on track to exceed 50% of Chinese GDP this year.
Demand Side Shows Discomforting Signs
- Evidence of a sharp slowdown in Chinese import growth.
- From Jan-April 2005 y-o-y import growth was 13.5% versus 36% in all of 2004.
- This has implications for the rest of the region, which provides China with capital equipment and intermediate inputs for its export businesses.
Chinese Import Growth Fuels Pan-Asian Exports
- 20% of total exports from Korea, Taiwan, and Japan go to China (Singapore - 10%).
- Slowdown in Chinese import growth is already affecting Asia.
- In Taiwan, export growth slipped to just 1.2% y-o-y in Q1 2005.
- Japan's exports showed a -0.8% q-o-q, annualized export decline in Q1 2005.
- Hong Kong (+3.5% y-o-y in March), Korea (+7.4% in Q1 2005), and Singapore (+6.2% in March for non-oil domestic exports).
- In all of the countries mentioned above, the latest export comparisons represent a sharp deceleration from gains six months ago, when the Chinese import boom was cresting.
China's Import Slowdown Affecting Commodity Inflation
- This reflects China’s dominant role in driving world demand for industrial materials.
- Morgan estimates that China accounted for 8% of global consumption of crude oil, 20% of aluminum, and 30-35% of steel, iron, and coal.
- Deceleration of Chinese imports has been accompanied by a sharp deceleration of non-oil commodity inflation.
- The Journal of Commerce composite index of industrial materials is now down 3% y-o-y through May 20. Peak increases of close to 35% in early 2004.
- Commodity prices are one of the best real-time gauges of the interplay between global supply and demand.
- Emergence of negative comparisons for industrial commodity prices could well be a good leading indicator of further weakness to come in Chinese industrial activity.
Efforts to Curb the Property Bubble
- China's recent restraints on both supply and demand could finally lead to a bursting of coastal China’s property bubble.
- This could also lead to a meaningful slowing of growth in fixed asset investment.
- Fixed asset investment accounted for 44% of total Chinese GDP in 2004.
- Fixed asset investment was still growing at a 26.5% y-o-y rate in April 2005.
- Like exports, fixed asset investment is also accounting for about 11 percentage points of annualized Chinese GDP growth.
- Every ten percentage points of slowing in residential property investment could knock about one percentage point off total Chinese GDP growth.
Chinese GDP Growth Risks
- Externally-imposed constraints on exports.
- Internally-imposed restraints on property investment.
Roach Believes China's Policymakers will be Cautious
- Could mean a delay on currency reform.
- China’s new export taxes on textile products suggests that it may prefer tax policy over revaluation in order to restrain exports.
- Despite China’s intentions to manage its export problems, the US, which accounts for about 33% of total Chinese exports, seems prepared to make changes themselves.
Key Deficiencies of China’s Growth Model
- Excess reliance on exports and fixed investment.
- With little private consumption, the Chinese economy is vulnerable to shortfalls in either of these sectors.
- Private consumption accounts for only 42% of China's GDP.
- Conceivable there could be a meaningful slowing of the Chinese economy.
- It is likely to be driven by China’s internal measures as well as by anti-China actions.
- If that occurs, China’s Asian supply chain should be especially hard hit.
- A China slowdown could also result in further downward pressures on commodity prices of oil and non-oil industrial materials.
- Could also temper inflationary expectations embedded in global bond markets.
- If there is a delay in revaluation, pressure on the US dollar could be tempered.
- New and more difficult challenges today than before.
- Property bubble is an increasingly worrisome source of internal instability.
- The currency-export nexus has become an increasingly intractable source of external instability.
- China faces growing pressures to make change.
According to Roach:
....This time, it will be much tougher for China to avoid a meaningful slowdown. It’s time for the rest of the world to prepare for just such a possibility.Comment: Full article here.