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Forecasting China - Rebalancing - Change And Discontinuity

Economics / China Economy Jul 26, 2013 - 06:25 PM GMT

By: Andrew_McKillop


Forecasting China trends is now a hard ride. The days of rock solid 10%-a-year growth are going, going, gone. Like the celestial Dragon which Chinese astrologers place at the center of their Magic Square – able to appear or disappear without warning to the 11 other real Animals such as the Monkey, Snake, Cat or Horse. China has woken up to what is a new problem for Chinese, but not for others. Its slowdown of economic growth, but possible slump into very low growth was a process that took about 40 years for the USA and 20 years for Japan - but may may only take 10 years for China.

Just as important, China wants slower growth. This will not be a so-called “surprise slump” as it is always portrayed by government-friendly media in the Old World, dominated by what Chinese call “the Western Barbarians”. As I reported in another article, China's culture of national humiliation  ( has a major undercurrent impact, speeding the country's morph into a new economic strategy.

We are learning that the aggregate effects of rebalancing underline a broader point — this is real discontinuity— which will cause changes of national and global significance. China's rebalancing is headlined as a switch from quantity to quality and from corporate investment to domestic consumption, but is presently shown by a flurry of mostly smaller changes – which are already having major aggregate impacts. Now however the gloves are coming off and bigger “stepwise changes” are in the offing. These especially include the very troubled banking and finance sector, used by China's leaders operating their own QE of credit-fueled investment to force growth back, after overseas export demand faded in the 2008 crisis.

This produced an unwanted result. The share of industrial investment in GDP continued growing, to 48.1 percent in 2012 from 41.6 pc in 2007, as local governments built roads and airports, factories and even coal mines or steel mills, property developers threw up forests of hard-to-sell luxury apartments, and rural Chinese went on flocking to the cities. This is now a rearview image of China.

Due to the still-centralized, still-secretive nature of Chinese policy and decision making, things that might not happen but which would have a big impact if they did, can happen. Some are already doing so, which only underlines what rebalancing also means – this is major national change that may or may not be entirely under State control.  The New China which comes out of it will be different.

The extent to which China has changed “in front of your very eyes” is shown by stark examples. One is China's oil import trend, now down to very nearly zero growth, reflecting what are aggregate major industrial, energy sector, economic and policy changes. To be sure, the effects of China's rebalancing on world commodity demand and prices will be major and negative.

Reviewing China forecasts for 2009 is now time travel and science fiction flavoured. At the time, herd analysts hailed China's “permanent boom” as firstly permanent, and secondly able to pull the OECD economies out of their tailspin. They were wrong twice over.

These were, for example, the last days of China's riotous credit expansion fueling the real estate boom, before both the bank and real estate sectors became “fully nationalized” long-term crises. One anecdotal change has been a decline since 2009 in the number of new housing blocks collapsing from lack of proper foundations. The hurry has gone, or is going.

Less anecdotal, China’s overseas investment strategy was already starting to downsize and refocus, but since 2009 the cumulative change has been massive. Showing the real world impact of this, we could backtrack further, to 2005, and Lenovo's high profile and high cost buy-out of IBM's small computer PC business. What we find is this was almost certainly the very last major corporate purchase by Chinese interests in the US or international high tech sector.

The example can be multiplied several times over, in the shape of failed or aborted, hostile takeover attempts by Chinese corporations, and growing anti-Chinese sentiment in Western media. 2009 was the watershed. Rebalancing most certainly and surely includes a new, very different attitude and policy by Chinese interests concerning the purchase of overseas assets.

As we know and Chinese know, outsiders “committed to free markets” ritually condemn China's command economy while hoping the command economy will create easy pickings for them – the old story – but this is interpreted by Chinese as meaning they must never lower their guard.

China's centrally-planned leap into electric cars (EVs) was a major example. The commitment to developing the world’s No 1 EV industry and beating the West was substantial, but is now massively watered-down and has morphed into a major structural rethink for the industry. Several billions of dollars in subsidies were heaped on production and huge incentives for potential buyers, equal to those in Europe, the US and Japan despite the average income difference, were handed out. Being centrally-planned, China also issued “fiat directives” for government purchasers to buy electric.

The original program called Promoting the Automotive Industry, in 2009, set an official target of 500 000 EV, hybrid, and mixed vehicles on Chinese roads by 2011. The actual volume turn-out was about 97 percent less at 15 000. This was a wake up call.

As elsewhere and to date in China, consumers have largely rejected EVs. Unlike what its intense marketing and publicity claims for Tesla Motor in the US, selling itself as “the Apple of EV tech”,  EV technology failed to live up to the costly commitments of Chinese auto companies. The nearest thing to Tesla marketing, in China, is already some way back in time and featured “western interference”. This was the short-lived boom for EV builder BYD, nicknamed 'Build Your Dreams'. The firm was firstly given the kiss of life, and then of death by Warren Buffett who in a blaze of publicity bought in, held for a short while while share prices grew, and then sold out. BYD share prices collapsed.

At least as fast as elsewhere, Chinese corporate and central planners made a major rethink on EVs. Their conclusion is EVs have a role to play in cutting urban pollution, but problems and challenges running from battery tech to commercial operating formats for EVs all need research and study. Wanxiang Corp’s recent purchase of failed US EV battery tech company A123 Systems is a case in point. This is longer-term and smaller-sized, research oriented strategic investment. It suggests there can be a second wave for EVs in China, but the scale will be small or very small until the 2017-2020 horizon. At the same time, China powers on with natural gas powered vehicles.

Running back to the 2005 crop of large-sized strategic tech sector overseas purchases led by Lenovo and the smaller high-tech industrial investments in Mexico by Foxconn and Haier, we can say they are unlikely to repeat, despite the rationales. These featured rising production costs inside China and a domestic market not yet ready for the products, as well as trade and tariff issues.

This is pre-2009 thinking. Chinese manufacturers are now unlikely to act as boldly or diversify geographically as they did. Rebalancing, here as elsewhere, means staying close to their existing supplier base and, even if slower growing, local market. Avoiding complexity and uncertainty, and perceived hostility far from home is proving more compelling, which underlines the under-recognized role of China's “traditional suspicion” of the West in particular, and foreigners in general.

Chinese view themselves as changing faster than foreigners are changing their views, or willing to change their views of Chinese. In other words the “paranoid and revanchist” undertow is still running. It can be argued as having plenty of ammunition. Western countries are making it more and more easy for China's fear of rejection staying a powerful deterrent to large-scale Chinese acquisitions in the United States and Europe. Outside of the US, Europe, Japan and Korea and technology investing, the same rebalancing theme concerns the developing countries and natural resource commodity and agriculture investing. China is moving away from almost any large-sized overseas projects which all too often for Chinese, result is political fallout and blowback driven by jealousy or fear.

Specifically concerning US-Chinese relations, the American Chamber of Commerce in China is currently developing an initiative to overcome the “suspicion barrier” and persuade Chinese companies invest in the United States.

Rebalancing will likely cause a major fall in China's overseas investments, across the board. Previously high profile sectors – electronics, PCs, cellphones, network equipment – show this trend already, with basically no major Chinese acquisitions overseas since 2008. Also important, the number of disputed or hostile takeover attempts ending in failure has been sufficient to harden China's thinking against this strategy.  Many observers now say that the changing political climate – inside China and attitudes to China outside the country - : make it unlikely that the 2005 Lenovo acquisition could be sealed, today, if this M&A were to repeat in today's circumstances.

Recentering the economy on the domestic sphere is shown all across China's massive industrial system and perhaps most intensely in the high tech sector including computers, telecoms, solar and windpower equipment. In all cases rebalancing also means a reinforcement of State control, due to too much State backed and facilitated easy credit driving unrealistic investment and capacity growth. Competition is now more “guided” than previous, made easy by Chinese corporations being heavily overstretched through so many years of so-called “breakneck” investment growth. Competition in the telecom sector, for example, has declined to a shadow of what it was and has superceded the expected consolidation in the sector. Government-orchestrated shifts of investor shareholding power operated by new policy and regulatory decrees have frozen the dynamic of change – to protect telecom operators with large legacy fixed-network assets. Opportunities for overseas investors moving into China telecoms are therefore low to very low, in fact close to zero.

Much more critical action is underway, and sorely needed in China's troubled finance and banking sector. Here again, the timid inward investments – often called encroachment by Chinese – of foreign banking entities are likely to slow or halt. The retreat of foreign bankers is sped by China's own QE Taper Down. During the 2008 financial crisis, China’s central bank injected the equivalent of trillions of dollars into the system to stave off collapse but as I reported in other recent articles, the cash tsunami also inflated the shadow banking sector to monstrous proportions. China's QE accelerated the continued build-out of oversized economic infrastructures geared to the cult of 10%-annual-growth, right until late 2012. To be sure this saved the country from the worst of the post-2008 global slowdown, but the result is recognized in China as “fool's comfort”. Now, the central bank (PBC) is operating a gloves-off strategy with the banking and finance sector. It is forcing “de-risking” alongside deleveraging, and marks perhaps the key component of the rebalancing strategy.

China is no longer interested in off-balance sheet wealth management products promising massive returns at high but disguised risk. Some mainland bank investment at a modest level is continuing with Taiwan but as of end-2012 only four mainland banks had a branch or suboffice in Taipei. Major new international bank and finance sector acquisitions by Chinese interests are likely to remain highly subdued for several years ahead.

Industrial and financial restructuring is now moving fast but has not yet heavily impacted China's strategic investment interest in food and energy. These two can be called “protected sectors” but the length of time that will continue is not possible to forecast.

Recent jumps in food and energy prices reinforce State interest in the sectors. The Chinese fear of food shortages is maintained by the country's highly strained food sector, vulnerable to harvest disruption, bad weather or disease, and destabilized by decades of agricultural reforms basically aiming for higher productivity. The flow of rural migrants supplying cheap labour to China's growing eastern cities was taken as “permanent”, but this mentality has given way to fact-based reasoning. Imports of agricultural products have grown at a particularly fast rate since 2010. In 2012, China's trade deficit on food products was about $56 billion.

In the agriculture sector, productivity gains can outstrip labor cost growth only if the pace of investment holds up. This however is dependent on rural-urban rebalancing which is a politically sensitive, heavily discussed subject in China today. The push to boost economic growth through domestic consumption cannot avoid a rise of minimum wages, resulting in more demand for non-traditional and processed foods, one major cause of rising food trade deficits, but reports suggest that agricultural enterprises and entities are struggling to achieve matching productivity gains as they pay higher wages, to attract or hold specialized labour.

Overall, the country is now getting a clearer understanding of the trade-offs between hiring factory workers and making capital investments in urban areas — or in new generation rural investments aimed at reducing the country's dependence on food imports at prices China cannot control. This is a massive change of policy, with major economic impacts including slower economic growth in the short-term or mid-term.

The “protected sector” rationale also applies to energy but here, until very recently, the strategy meant almost exclusive overseas investment. The years 2011 and 2012 were bumper for outbound acquisitions by Chinese oil and gas energy-focus companies. This included Sinopec, Three Gorges Corporation, the China Investment Corporation, China Guangdong Nuclear and other majors investing close to $22 bn around the world in 2011-2012 to acquire energy, mining and natural resource assets

Analysts are cautious to forecast at what rate Chinese energy-sector, natural resources and mining investments will scale back, but nearly all agree the rate will be impressive. Apart from radically growing domestic shale-focus oil and gas investment, the country is wrestling with critical overcapacity in the solar and windpower sector. This was an ultra protected sector, taken to particular extremes in solar power panels, with the country's “nameplate capacity” for manufacturing panels close to 45 GW (45 000 megawatts) a year - to set against world total demand of about 30 GW a year! China installed about 5 GW of solar capacity in 2012, double the 2.6 GW achieved in 2011, itself four times the 2010 figure, making the country the world’s number-two end market for solar, due to government support. This is now inevitably declining – the only subject for debate is the rate of decline.

However the main factor impacting the energy sector again underlines the dramatic changes that have happened since 2009. All major energy demand drivers have turned down. In a single figure, the domestic automobile market was still growing at over 30 percent a year in 2009. In 2012 the growth was about 8.5 percent, and for Chinese-owned companies not operating JVs with overseas partners, the rate was 5 percent. The small-volume high priced car market bucked this trend, and grew more than 15 percent, only showing the extreme rapidity of the country's car market maturation.

Declining growth of the domestic car fleet, and improving fuel efficiency, as well as increasing limits on urban car utilisation to limit pollution are all taking their toll on oil demand growth. China's coal industry surely faces downsizing, or at most flatline growth, signaled by another “shock statistic”, that is low or near-zero growth of national electricity demand.

At the same time, China's overall return on investment has fallen by about a third in under 20 years, according to the International Monetary Fund. Since 2009, according to Fitch Ratings, each yuan of lending in China now produces just one-third the payoff as raised GDP that it produced before 2009.

This only leads us to conclude that rebalancing is a national strategy that was overdue, but its effects are certainly going to take time being felt, and will also be global. The length of time the rebalancing strategy will continue is likely to be long – but will surely be exposed to periodic “headwind” crises able to thwart its overall goals.

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2013 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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