May 16, 2012

The slowing dragon

China slows down for good

Economists working for investment banks are more bashful than the IMF. They forecast ‘only’ 8.5 percent GDP growth for the Chinese economy in 2013. In its latest (semi-annual) World Economic Outlook, the International Monetary Fund projected GDP growth for China at 8.2 percent in 2012 (same as what it forecasted in September 2011) and at 8.8 percent in 2013.

Scouring through its forecasts of growth for many other economies, one notices that most of them have been marked down. India’s growth forecast has been reduced to 6.9 percent for fiscal 2012-13 from 7 percent (as of January 2012). That was lower than the 7.5 percent forecast in September 2011. Of course, China’s growth numbers were lowered from 9.0 perecnt and 9.5 perecent for 2012 and 2013 to 8.2 percent and 8.8 percent in January from September 2011. They still appear too optimistic. The growth forecast for India is more realistic.

One cannot blame the IMF. It is run by a European and it wants China to buy European bonds. No point in angering the dragon with a drastic growth mark-down in succession. However, since the January forecast revision, China’s economic data have been, for the most part, disappointing.

The Chinese New Year occurred in January this year. Yet, in February, China recorded a trade deficit as exports collapsed. In handling the problem of bad and souring debts to local governments, China has asked its banks to roll over the debt to prevent them from being classified as non-performing.

Photo: Dainis Matisons

China’s power output is down and Foreign Direct Investment (FDI) has been declining every month (y/y) for the last three months. With export growth arguably in terminal decline and with domestic demand being held back by curbs on bank loans to local governments and to the real estate sector, it is unclear if economic growth could be any higher than 3 percent or 4 percent.

Of course, neither would China publish such a growth number nor would any China economist make such a forecast. In a recent CNBC interview, the China economist for Citigroup suggested that annual growth rate might drop to around 7.5 percent in the third quarter of this year and accelerate from there. Independent economist Andy Xie said that the slowdown had just started and that it was a multi-year process.

One needs to look at other indicators such as corporate profitability to gauge the extent of slowdown underway in China. Recently, Caixin magazine published some articles on profitability in the steel sector, on the extent of provisioning for non-performing loans in China banks and on the profitability of State-Owned Enterprises (SOE). Here are some key facts:

  • Data from the China Banking Regulatory Commission indicates that as of late 2011, total assets of China’s banking industry reached more than 113 trillion Yuan, up 18.9 per cent from the previous year… As of late 2011, the amount of outstanding bank loans was 54.79 trillion Yuan. Every per centage point increase in the NPL ratio means banks face a potential loss of 548 billion Yuan. Assuming 2011 profits were already excluded in NPL provisioning, around 2.1 per cent of total loans, it would have been completely consumed if 4.1 per cent of loans had been lost. (Source:

It is obvious that the last sentence has been badly translated from the original Chinese. One guesses that the messages is this: 2011 profits might have already provided for 2.1 percent of total loans but had it provided for 4.1 percent (of total loans) for non-performing loans, 2011 bank profits would have been wiped out. Further, regardless of what one says about China’s labour productivity, its focus on growth, its policy prioritisation, etc., it is hard to miss the dangers inherent in the banking sector assets being 300 percent of GDP and bank loans being 160 percent of GDP. Many dynamic economies have been brought to their knees by a deflating credit bubble.

  • According to the Ministry of Finance, state-owned enterprises (SoE) registered a drop in profits during January and February compared to the same period last year. Total profits for the two months hit 363.5 billion Yuan, down 10.9 per cent year-on-year. Centrally-administered SOEs saw similar decreases in profits, at 212 billion Yuan, down 11.5 per cent. The figures represent the second decline since 2009. (Source:
  • The China Iron and Steel Association (CISA), a national industry organization, said profitability for the steel industry in the first two months fell 68.4 per cent compared to the same period in 2011…………This would be the first time for the whole sector was in the red since this millennium, the official said. (Source:

“Forensic Asia”, an independent research outfit in Hong Kong (disclosure: I am a consultant-economist with its sister-concern ‘Asianomics’) has this to say about overall Chinese corporate profitability and not just that of SoE or the steel sector alone:

  • Evidence of a slowdown is becoming increasingly apparent. The HSBC Purchasing Managers’ Index has been in negative territory since July 2011, with the exception of October, registering a reading of 48.1 in March, below expectations, as Figure 12 shows. Interestingly, the government controlled PMI released by the China Federation of Logistics & Purchasing actually showed a sudden expansion. However, this index has been known to get it very wrong in the past, perhaps because it is the only PMI that we are aware of which is compiled by a government organisation. This slowdown in manufacturing activity is reflected in corporate earnings which are posting the highest level of negative disappointments relative to expectations since 2H08. Indeed, Figure 13 shows that the net disappointment for 2011 results has been 31 percent. This means that 66 percent of companies have posted 2011 results below expectations.
  • A big miss for 4Q earnings. Whilst the majority of companies have missed analyst earnings expectations, the average miss is about 4.5 percent for the year. This may not seem like much but analysts were only forecasting the fourth quarter, with nine month results having already been made public. It would be more appropriate to suggest that companies missed their fourth quarter earnings estimates by around 20 percent. (Source: ‘China Property: Just a bad dream?’, Forensic Asia Limited, April 18, 2012)

Since the losses in the steel sector are attributed to overcapacity and rising cost of iron ore, it is interesting to examine the parallel with the banking sector. Overcapacity is clearly the case with China banks. Far too much of credit has been created. But, it is being saved by under-provisioning. Input cost has been kept artificially low with ceilings on interest rates on deposits.

Clearly, India benefits from a slowdown in China. One can state that even without invoking a geo-political balance of power narrative. Indeed, most nations will benefit from a slowdown in China. They will see investor interest in their economies and in their markets. On this score, India will not see big gains because India has not prepared itself to benefit from the inevitable loss of competitiveness of manufactured exports from China as it grows richer. Other East Asian and least developed nations in South Asia might benefit more. Growth rate in Asia, ex-China, will improve. Korea and Japan stand out as obvious beneficiaries, followed by Thailand, Philippines, Malaysia and Indonesia, perhaps, in that order.

Global prices of commodities will decline. Many nations are commodity users; only few are producers. The latter will be hurt. But, from a global perspective, gainers outnumber losers and gains will exceed losses. India, with its substantially large trade deficit and commodity imports, will get some relief from the decline in commodities that would necessarily follow the slowdown in China.

Beyond this, Indian readers should resist the temptation to gloat. If the obsession of the Chinese Communist Party to retain control over the economy through its stranglehold on the banking system is likely to cause the unravelling of China’s growth, Indian political class is no less guilty of similar crimes. Its control of the financial sector is as pervasive as China’s and just as harmful:

  • Real deposit rates in India are negative. The new consumer price index showed that inflation was just within a whisker of 10 percent in March 2012.
  • The Reserve Bank of India cut interest rates by 50 basis points even as the pre-conditions it laid out earlier for future interest rate reductions were not met. It risked its credibility with the larger than expected rate cut and the consumer inflation rate has done its credibility no good.
  • Public sector Life Insurance Corporation bought the government stake in the public sector enterprise Oil and Natural Gas Commission to help prevent the public sector budget deficit from becoming more bloated.
  • It has frequently resorted to loan waivers undermining the banking sector health and the culture of loan repayment in the country.

There is one more reason for India to display humility. Niranjan Rajadhyaksha of MINT wrote recently that every time China’s growth rate converged towards that of India in recent decades, it has managed to pull away through decisive reform measures.

For all its flaws and faults, China’s Communist Party bats for China. In the final analysis, that is the most important advantage that China has, over India.

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