China Retreats from the Headlines as Solid Growth Returns

As foreign leaders were arriving in Hangzhou, China for the G-20 meeting earlier this month, President Xi Jinping reiterated the country’s commitment to major changes to put China’s economy on a more sustainable path: reducing debt, shrinking excess industrial capacity, relying less on government infrastructure investment to keep growth going, fighting corruption, and becoming a consumer-driven society. Hosting the meeting was another chance for China to exhibit its new important position in the world. Xi was eager to send a reassuring message that China will continue to be a medium- to high-growth participant in the world’s economy, even while changing the engines of that growth. He also called for the world’s nations to lower barriers to trade and investment.

As if on cue, the latest economic indicators from China reinforced Xi’s message. China’s growth has stabilized. Industrial production and investment are looking stronger than in some time, reversing a decline that began in March. For those skeptical about Chinese data, the Purchasing Managers’ Index—believed to be a very reliable indicator, even by skeptics—rose to above 50, its highest reading in two years.

Early in 2016, all the news seemed negative, leading to credit downgrades and concern over the effects on the global economy of a sharp downturn in China’s growth. Those headlines have fell off the front pages for now as China enters the fourth quarter apparently on track to reach its target of 6.5-7% growth this year. Although, more credit and more government infrastructure spending took momentum away from Xi’s objective of changing the source of growth.

It’s clear that the government is focused on economic change, but will use the old instruments when needed—even if they cause a delay in transforming the economy. The challenge of changing the engines while keeping the plane in the air will be a constant balancing act. However, it’s important to remember that the Chinese government is in control of large sectors of the economy and has many tools at its disposal to manage a path of solid growth.

Heard from US Companies and the Official Data

Beyond the headlines, when we talk with friends working for foreign companies in China we hear sentiments ranging all the way from highly optimistic to severely depressed.

• Suppliers to energy, mining, construction, heavy industry, and the traditional light industry’s low-value-added exporters have yet to see light at the end of the tunnel. Factories are not being built, equipment is not being replaced, and the global depression in raw materials has exploration and processing on hold. Buyers have also responded to weak demand for their products by becoming more price-sensitive in their buying, a change that does not bode well for US and European suppliers, even when recovery returns.
• China’s heavy infrastructure spending, which drove growth for the past decade, has slowed as it naturally would with so many roads, airports, rail lines, and subways having been built all across the country. It is also slowing because the government wants to shift the engine of growth away from its spending. Construction equipment and materials suppliers are suffering from the lack of demand. At the same time, that infrastructure is allowing economic development to shift to more and more remote regions of China. The consumers in those areas that had barely experienced China’s dramatic change are seeing it now and their consumer demand will be an important driver of growth going forward.
• Consumer markets are where China’s growth is already powering ahead. Meeting with executives in the auto industry this month, we hear only confidence in the future, along with new plans for being part of the solution to transforming China. China is now the largest new car market in the world by far and it has also long been the most competitive. Joining every major global OEM producing in China—in joint ventures with Chinese OEMs—are a new set of Chinese auto OEMs. While the local companies are not regarded as competitive with the global brands, some are becoming very aggressive to raise their market position, as with Geely acquiring Volvo.

Looking at year-over-year growth in industry production paints a very clear picture of the shifts in the Chinese economy. The highest-growth industries are those meeting the rapidly-growing demands of China’s consumers: processed food, medicine, auto, and computer and communication electronics. Processed food is an interesting example of China’s changing market. A decade ago, we reported to one client that frozen food items were beginning to appear in grocery stores. Today, the freezer cases are prominent in modern grocery stores in major cities, holding dumplings, ice cream, and imported beef. We were given free samples of frozen pizza last week in a corner grocery in Beijing, showing just how much China has changed.

Looking Ahead

China’s growth has resumed and the optimism in global financial markets over China’s future has returned. Still, the challenges are great of transforming an economy driven by government spending and favoritism into one centered on consumer demand. As in the US, very few Chinese or global investors seem to have factored into their assessments any chance of a 45% tariff on Chinese exports under a Trump administration. There almost surely will be at least a temporary shock to the markets should Trump be elected. The eventual outcome depends on whether a pragmatic Chinese leadership finds itself able to work with a Trump administration. Our belief is that practical solutions will win out, but it’s a bit worrisome that no one seems to be considering the risk that it does not.