"End of an era" for China

Independently adjusted figures from banks and other commentators pointed not only to a sharper slowdown, but also to the beginning of a long-term secular shift in growth drivers – and consequently investment opportunities for private equity – from export-oriented industries to the domestic consumer base.

Real figures and underlying trends

Dong Tao, MD for Non-Japan Asia Economic Research at Credit Suisse, described the official figures, as "on the optimistic side. This is a view from year-on-year numbers." He said that based on annualized projections from the quarter-on-quarter numbers, China's economy is growing at more like 7.8%,–"a significant slowdown from the previous quarter."

Goldman Sachs also estimated around 8% for the second quarter on an annualized basis, with Standard Chartered seeing closer to 10%. And in Tao's view, the slowdown by year-end would be even more significant. "Toward the end of the year, we would expect the Chinese economy to be growing at 6.7%."

It is important to note that this picture is uneven among the various regions in China, and among sectors of the economy. Industrials have weakened the most, falling from 16.7% to 13.3% over the quarter. "Some of the steel factories have suspended producing; some auto factories have suspended production because of the headwinds that the economy is going into," Tao noted. The falloff of this, chiefly inward-directed, activity is due primarily to the withdrawal of stimulus measures and the cooling property sector.

There are already signs of short-term moves to counter the trend, with CITIC Securities stating that the central government may instigate more programs to boost domestic demand, such as supporting low-cost housing in order to offset the export and manufacturing weakness. China International Capital Corporation (CICC) economists also noted that the government may speed up approvals of investment projects, as Premier Wen Jiabao publicly advocated measures to boost domestic demand to offset the slower-than-expected global recovery.

Yet, even with reports from the State Information Center warning that export growth will fall by half from 35% over 1H10 to 16.3% in 2H10, some China-watchers remark that domestic, rather than external, falloff in demand is the problem. "The export sector is also doing well," observed Tao. "Most of the Chinese exporters have orders all the way to the end of this year, and some all the way to first quarter next year."

More importantly, though, as Tao adds, "while the manufacturing PMI [purchasing managers' index] is heading down, the non-manufacturing PMI actually edged upwards, which is very significant." In other words, the services sector is moving up. And importantly, while Beijing, Shanghai and the PRC's other first-tier cities slow down, the third-and-fourth-tier cities and regions are actually picking up. Private equity firms like Infinity Group that made a policy of developing local platforms in less-visited cities such as Harbin and Changzhou, may prove the beneficiaries.

How an era ends

These developments are the first symptoms of the major shift to domestic impetus in China, already catalyzed by some policy moves and soon to be accelerated by more. For one thing, China's 2008-09 stimulus investments into its inland provinces have triggered demand growth. "In the remote areas, the infrastructure investments are starting to pay off," Tao remarks. Better logistics networks, as well as personal investments by individuals in agricultural equipment, cars or trucks, have created new wealth-generating potential and consumer demand away from the export-oriented east coast. "Escalation in the third- and fourth-tier cities is driving up retail sales," deduces Tao.

On top of this, though, comes a government-mandated movement towards higher salaries, which "marks the beginning of the end of an era" in terms of China as the low-cost factory floor of the world. "Every year, we expect 20-30% salary increase," Tao forecasts. "This is going to be shocking to China's export base."

Partly, this development reflects China's move up the value chain, from competing on cost alone to increasing value-added work, with the added fillip of growing domestic demand to drive a virtuous cycle. Even export-oriented businesses are unlikely to leave China for Vietnam and other cheaper labor markets, Tao feels, because China now competes through the integration of industry supply chains and more effective logistics as much as labor costs.

Overall, Tao testifies, the axis of world economic growth has now shifted permanently away from the West. "What's driving the growth is emerging markets. It's not the US or Europe," says Tao, adding, "this is about the contribution of China alone. China is contributing to global growth as much as the US, Europe and Japan together."

"China is heading for a cyclical downturn," he concludes. "But it's equally clear that the rise of agricultural prices and salaries is promoting consumption. Let's not mix the cyclical outlook with the structural outlook." Private equity firms that have invested these propositions, such as the Carlyle Group with its commitment to the Chinese subsidiary of Thai animal feed maker C.P. Pokphand Co., and the Blackstone Group, Capital International and Warburg Pincus, with their support for wholesale vegetable markets operator Dili Group Holdings, are just outriders on a general macro trend likely to generate far more opportunities – and upheavals – in the near future. 

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• Performance
• Warburg Pincus Asia
• The Carlyle Group
• The Blackstone Group
• Infinity Equity
• Capital International