Rudi's View | Sep 20 2007
By Rudi Filapek-Vandyck, editor FNArena
Economic growth in China is slowing. The only reason why you haven’t read this anywhere else yet is because it hasn’t shown up in official economic headline data just yet. But it will.
As every smart economist will tell you, headline economic data seldom tell the whole story. At face value growth in fixed asset investment (FAI) in China accelerated in August to 27.3% year-on-year from 26.4% in July. Some market commentators have suggested this was the trigger for the People’s Bank of China’s (PBoC) fifth interest rate hike for 2007 earlier this month.
In reality the opposite is true. Fixed asset investment in China experienced a significant drop from mid-2006 onwards with July’s FAI data more than 5% lower than June and August again some 5% lower than July. After a slight pickup in September, FAI data sank to their lowest point for the year in October.
This makes this year’s growth in FAI in July and August look stronger than it is.
A scenario of slowing economic growth in China would be consistent with gradually lower data for other economic indicators as well. Growth in industrial production, for instance, slowed to 17.5% in August from last year. While this is only slightly lower than the 18.0% recorded for July, the August headline figure was the weakest recorded in three months.
A gradually slowing Chinese economy would also be consistent with economist expectations that the next few years will see China report growth figures of 9-10% instead of the 11-12% registered throughout 2006 and earlier this year. Not everyone agrees with this view though. To some experts China remains a pressure cooker of hot investment money and abundant cash flows and this easily explains why economic growth in the country has continuously surprised on the upside over the past few years despite a plethora of (gentle) government actions to rein it in.
One of such actions -the most important one so far this year according to some experts- was announced last Thursday when China’s State Council ordered State Owned Enterprises (SOEs) must start paying dividends in 2008 based on their 2007 financial accounts.
Why is this so important?
Chinese companies don’t have a habit of paying dividends. They prefer to spend their large cash flows on new investments instead. This has made a large part of the economy effectively immune to government intervention as well as to higher interest rates. It also explains why the country continues struggling with overinvestment and excess capacity.
Experts believe strong corporate cash flows have been the single most important driver behind the corporate investment boom in China. Forcing companies to pay dividends, of which a large part will end up in government budgets, will put the brakes on growth in private investments. While Thursday’s announcement is only targeted at State Owned Enterprises (in other words: those companies effectively controlled by the Chinese authorities) few doubt the next step will be targeted at non-SOEs.
The legislation for these forced dividend payments has yet to be formulated and put in practice. As always, China’s policy makers operate through decisive steps, but never in a hurry.
A slowing economy in China is not exactly the next item on investors’ wish list amidst growing concerns that economies in the US, Japan and Europe might well underperform in the year ahead. Especially since we’re all still awaiting the exact impact from the global liquidity crunch on the real economy while China, and the rest of Asia, are supposed to remain largely unaffected due to the region’s more insulated financial infrastructure and large capital account surpluses.
But a slowing Chinese economy does not necessarily spell disaster for companies and investors in Australia. In fact, say Commonwealth Bank economists Michael Blythe, Tobin Gorey and David Moore, it’s about time investors woke up to the fact that it’s not just China anymore that has awoken in Asia, it’s the whole region now.
Originally focused on exports to the US, Asian countries have developed their own domestic markets in recent years and Commonwealth Bank believes this development now looks strong enough to withstand the negative impact from a slowing US economy. As it happens, to most Asian countries China has now become the number one export destination while domestic markets continue growing strongly.
At current growth rates, says Commonwealth Bank, the Asian domestic market will equal the US domestic market in size as early as in 2010.
It’s a view that is shared by the Asian Development Bank which this week released its latest ‘Asian Development Outlook’ with increased growth expectations for the region. The ADB raised its average growth forecast for developing Asia to 8.3% for this year and to 8.2% for 2008 while stating the boom in Asia has now spread to a wider range of countries outside China and India. As such the region should be able to weather a potential slow down in the US.
For Australia, the most immediate benefit from this will be through higher prices for commodities. Let’s face it, without the Asian boom price prospects for the likes of zinc, nickel, aluminium and copper would look very, very shaky.
It’s still anyone’s guess at what price levels base materials will settle in the year ahead. Most experts foresee somewhat lower prices than this year, but any serious slow down in the US economy is not included in these forecasts.
The more bullish forecasters hope that ongoing strong demand throughout Asia will largely compensate for the potential loss of demand from slowing economies elsewhere.
However, there’s only one consensus in securities analysts’ expectations and that is that bulk commodities coal and iron ore will post another strong price rise, potentially for both 2008 and 2009. Not even oil or gold have managed to achieve such a strong and uniform market consensus.