By Jolette Persson, Hottinger Capital Partners
Q419 Chinese GDP growth of +6% year-on-year was in line with expectations. Industrial output at 6.9% and retail sales at 8% both surprised on the upside as the US and China came closer to their ‘phase one’ trade deal. Although it is encouraging to see that demand for spending and consumption has somewhat picked up alongside a steadily growing CPI – currently at 105.4 (though some of this is directly attributed to pork prices rising as a result of the African swine fever)[i] – property and infrastructure investments continue to slow. The fact that these are both key drivers of growth challenges the perception that China’s deceleration is coming to an end. China has historically built its economic growth on low-cost manufacturing, machinery and equipment and built its cities around factories to attract labour. As a result, close to a quarter of China’s economy is in real estate [ii].
India, another key driver of Asian growth, is expanding at its slowest pace for the last six years, down from close to 7% to 5% during 2019, followed by what has been a period of the weakest industrial production output in the last 8 years, high unemployment rates and slowing consumption. A decline in manufacturing might suggest that India’s economic issues are deeper rooted than initially thought, particularly as recent tax and interest rate cuts do not seem to have had a material effect on the economy. More concerningly, economists predict that India must grow in excess of 10% per annum to support the 12 million young workers entering the labour market every year [iii].
China being the world’s largest exporter by value (~$2.5trn) means that the magnitude of the effect of China’s growth on global growth is enormous. To put that into perspective, a 1% drop in China’s GDP shaves off 0.2% of global growth. This should not come as a surprise considering that China’s GDP represents approximately 19.24% of world GDP [iv]. In Europe, there is a clear relationship between the Chinese purchasing managers index and exports. Germany, with China as its largest trading partner, is likely to take the biggest hit from slowing Chinese growth of the European countries. For decades, China has provided a steady stream of income and contributed to growth in sectors such as automobile, machinery and engineering tools. German carmakers such as Volkswagen, Daimler and BMW all generate at least a third of their revenue from China, which has slowed significantly as a direct result of trade war tensions and their effect on Chinese demand for consumption, particularity on big-ticket items [v].
In the rest of the world, China’s largest trading partners – the US, Hong Kong, Japan and South Korea – have all suffered as a result of its slowing growth. Hong Kong’s economy contracted by 1.2% during 2019, pushing it into its first annual recession since the financial crisis in 2009, driven by trade conflicts and anti-government protests. Mainland Chinese travellers have since stopped going to Hong Kong (where they used to account for 70% of tourists), causing hotels, restaurants and the retail sector to plunge. Hong Kong’s exports, which mostly come from re-exported goods from China, have also reached an all-time low. Similarly, Japan’s manufacturing and exports to China have declined and the consumption tax hike in October 19 has further dampened demand and put off Chinese tourists, who are usually a major source of retail spend on luxury goods (~$16.4bn/year).
In India, IMF economists commented at the beginning of the year that India was the primary party responsible for the downgrade in forecasted global growth in 2020. Although we do not necessarily agree that India alone, more so than China, is a determining factor in global growth considering that it is a merely domestically-driven economy, India remains the fastest growing trillion-dollar and fifth largest economy in the world. As such, its output is not to be dismissed. The trade fallout between China and the US has hurt, but the decline in domestic consumption is the bigger problem. This has led to poor business sentiment, most evident in sectors such as automotive and manufacturing, as companies are refraining from capital expenditure.
Who stands to benefit?
Factors leading to today’s picture allows other countries to fill the gap and represent opportunities for some investors. We have already observed a change in dynamics whereby companies that normally extend their supply chains to China are now considering other countries such as Indonesia and Vietnam. Vietnam has already seen a huge increase in production and exports of smartphones and consumer electronics over the last 18 months. However, debates over local Vietnamese expertise in comparison to that of China still represent a hurdle despite the appeal of lower labour costs. Other countries, such as India and Indonesia, could eventually get to the point where they are regarded as exporters, provided that they continue to invest in infrastructure and policy reforms. Other direct beneficiaries of the US-China conflict include Latin American exports. Mexico, in particular, has been an unexpected winner as it has built out its manufacturing capability. In contrast to many countries in the Southeast Asia region, Mexico’s free trade agreements offer guaranteed access to more than 50 countries and it benefits from its geographical location being in close proximity to the US. Taiwan is the exception to the rest of Southeast Asia, whose additional exports to the US rose a whole 12.46% over the year totalling $85.48bn in 2019. This is reflective of its mature local tech industry that in turn has allowed its factories to ramp up capability and speed, with companies such as Taiwan Semiconductor Manufacturing Co. taking world-leading positions in their application. Taiwan also benefits from its geographical positioning with close trade links to mainland China [vi].
Bearing this in mind, 70% of surveyed European companies said that their supply chains had been disrupted to some extent and that holding off further action until real clarity is provided on trade is no longer considered a viable option. As such, we are forecasting additional haste for those companies looking to relocate production as well as more emphasis on supply chain diversification to avoid large and concentrated negative impacts in the future. We will continue to monitor the situation closely [vii].[i] https://tradingeconomics.com/china/consumer-price-index-cpi [ii] https://tradingeconomics.com/china [iii] http://www.oecd.org/economy/india-economic-snapshot/ [iv] https://www.statista.com/statistics/270439/chinas-share-of-global-gross-domestic-product-gdp/ [v] https://think.ing.com/articles/germany-what-role-does-chinas-automotive-market-play-in-the-current-economic-slowdown/ [vi] https://www.ustradenumbers.com/country/taiwan/ [vii] https://www.china-briefing.com/news/eu-businesses-china-look-mitigate-trade-war-impact-eucham-2019-survey/