Wall Street Greek: China - Signs of a Collapsed Export Driven Growth Model

By Guneet Singh Sahni - China Analyst:

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Nowadays if you visit China, you will observe a bulk of goods including toys, garments and electronics occupying the store shelves, giving you much better variety and quality than before. This is thanks to falling demand for goods from the world's factory, especially from the U.S. and other western countries. After riding on a wave of five years of double-digit export-oriented economic growth, China seems to face a hard landing, if one goes by last week's trade figures. China's exports data turned shockingly negative (declined by 2.2% Y/Y) in November, the first decline since June 2001 and the largest fall since April 1999. Two-thirds of China's small-toy exporters closed shop in the first nine months of 2008, according to government statistics. Closure of high labor intensive factories, including those of toys, garments and electronics manufacturers has also aggravated social unrest, by displacing sacked workers back to the countryside.

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Global Liquidity Freeze - Culprit for Declining Exports

The global slowdown resulted in a decline of China's exports by -2.2% Y/Y in November, as against growth of 19.2% Y/Y in October. The export falloff, the first since 2002, came up against consensus estimates for 15.6%. Details suggest that the fall in headline growth was led by mechanical and electrical exports. Additionally, some major customers of Chinese buyers in the U.S. and Europe could not get letters of credit (LC), thanks to the lagged effect of the global credit crunch and its leading to cancellation of Christmas orders. While the global credit market is slowly returning to normalcy, lost Christmas orders will not come back. It's clear the global liquidity freeze has dealt a severe blow to many Chinese exporters.

Early Signs of an Industrial Recession in Asia

The sharp fall in imports by 17% Y/Y, as compared to growth of 15.6% Y/Y in October, suggests a significant downturn in China's domestic demand and production cycle. However, the steep fall of import growth (against a consensus estimate of 12%) is partly attributable to lower global commodity/energy prices. In addition, the threat of an industrial slowdown in Asia looms, owing to the warning signs of a collapse in inter-regional trade and weak domestic demand within Asian economies. Some of the lead indicators for this collapse are seen in data from Korea and Taiwan, where exports fell by 18.3% Y/Y and 23.3% Y/Y, respectively, in November.

Falling Chinese import totals are partly offset by the fact that a large part of the exports from Korea and Taiwan to China are used as intermediate goods in China for further export as finished goods.

Record Trade Surplus - Global Imbalance

The trade surplus for the month of November widened to a new record high of $40.1 billion, from $35.2 billion in October (as compared to a market consensus expectation for $32 billion). This trade surplus has surpassed all records held up by any country at anytime. China is going to come under severe strain from global economies to reduce this imbalance. However, China has once again reiterated that it will not appreciate its currency by the magnitude demanded by its global trade partners, so as to keep its export sector competitive.

Hard Landings Can Lead to Serious Social Unrest

The GDP growth rate for the third quarter, which slowed to 9% Y/Y, also signifies a major concern for the economy. The central bank has already cut rates four times since September. China's November Headline CPI inflation came in lower than expected, rising 2.4% Y/Y (against consensus estimate of 3.3%), compared to 4.0% in October. This is the lowest reading in two years. That is alright for the long term, but China has a serious short-term problem. Domestic demand is still too weak to replace exports. This is evident from its November retail sales growth data, which decelerated to 20.8% Y/Y from 22.0% in October. Experts widely believe that GDP growth below 8% could lead to social unrest within China.

Consequently, in an effort to save China from hard landing effects, the Central Economic Work Conference gathered the country's top leaders last week to set the tone for a "soft landing." The meeting ended with a pledge to maintain stable, healthy growth next year through domestic demand expansion and economic restructuring.

China Will Need Special Focus on Intangible Infrastructure to Avoid Social Unrest

The government has taken a series of aggressive measures to stimulate the world's fourth-largest economy. In one of its most significant moves, China announced the mother of all stimulus packages, estimated at $586 billion or 4 trillion yuan, to be spent over the next two years. The stimulus package also paid special attention to intangible infrastructure like health and education, which is the need of the hour to stall any social unrest.

China's Defensive Armor Against Global Slowdown

The biggest challenge for Chinese policymakers will be to avoid a hard landing. A number of economists have conjured up downgrades of China, to abysmal growth rate projections ranging from 2-8%. I believe China has enough room to move on both the monetary and fiscal policy fronts to tackle the slowdown, given its large current account surplus, FX reserves, fiscal surplus and slowing inflation.