China faces a major slowdown in the growth of its economy as investment spending loses its momentum and consumer spending fails to offset that, according to a new report from the Monaco-based investment gurus Pivot Capital Management.
Development in China has been driven primarily by capital spending, but relative to the economy that has now reached unprecedented levels – accounting for almost 90% of growth in the first half of this year. The boom cannot be sustained at current rates and the chances of a hard landing are increasing.
Analysis of industrial capacity, urbanisation and infrastructure development “shows that China’s industrialisation and structural modernisation are largely complete” – therefore its future long-term fixed capital formation needs are being grossly over-estimated.
China is “running out of easy ways to boost growth through investment.”
• The manufacturing base is increasingly mature and there are few areas where there’s an obvious need for capacity expansion. Its current steel production is greater than that of the European Union, Japan, the US and Russia combined. Despite idle capacity of 160 million tons of steel a year, additional capacity of 60 million is under construction.
In cement, having doubled its capacity, China now produces and consumes more than the rest of the world combined.
Because of the way electricity is subsidised, heavy industry is notoriously inefficient in use of energy – which has probably led to over-estimation of future power generation needs, an important area of capital spending in recent years.
• The movement of hundreds of millions of people from rural areas to the cities “is perhaps the most quoted fundamental trend that should drive China’s growth for the next few decades,” generating demand for construction, real estate and home equipment.
But, the Pivot researchers argue, the “numbers are not what they seem.” If the same definitions of what are classified as villages, townships and cities were used by statisticians as in other major countries, China is already one of the world’s most urbanised nations.
Potential for future growth in residential property is limited by a very high home ownership level (86% in 2005) and affordability – price-to-income ratios have reached 15 to 20 times in major cities and around ten times in regional cities.
• Infrastructure has been the prime beneficiary of the gigantic stimulus package launched late last year. But the economic justification for many of the projects is increasingly questionable.
China already has a highway system two-thirds to three-quarters the size of America’s, despite a vehicle population less than one-fifth the size. It has roughly the same number of bridges as the US, despite one-fifth as many rivers. The only area of infrastructure where further investment clearly makes sense is the rail network.
A lot of infrastructure projects are now in sparsely-populated inland areas (“bridges to nowhere”), or clearly primarily intended to be prestigious, such as the Qinghai-Tibet railway.
The Pivot study expects infrastructure growth to halve next year and go flat or even negative in 2011.
China bulls suggest that private consumption will overtake fixed capital formation as the engine of economic growth. But private consumption only accounts for about one-third of the economy. Even making optimistic assumptions, private consumption would have to grow three to four times faster than in the past decade to compensate for the imminent fall in fixed investment.
The coming decline in the rate of growth
Such expectations are “unrealistic.” The latest central bank survey of consumer sentiment shows that a record low 8.6% of households consider their income “adequate,” compared to 32% in the first half of 2007. This is “hardly star material” for a consumption boom now in China, say the Pivot researchers.
The labour market is another worry. Urban unemployment is far worse than the politically-manipulated figures suggest – probably more than double the level the government admits to, and perhaps as high as 27% of the work force. Almost a million university graduates who started looking for jobs last year are still unemployed, and about 3.5 million of this year’s graduates.
The Pivot study concludes that China’s economic growth is soon going to decline to 5%-6% a year, “and probably slowing down even more later on.”
This will have “enormous consequences on what China imports from the rest of the world as it shifts from commodity and capital goods into (most likely locally-produced) consumer goods and services.”
Gloomy stuff for bulls of the Middle Kingdom like myself. It suggests that if we want to invest in China, we need to be particularly selective and concentrate on the best-connected as well as the best-managed companies focused on future domestic demand opportunities.
• This article was written by Martin Spring in On Target, a private newsletter on investment and global strategy. Email
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