How Will China Weather the Financial Storm?

How Will China Weather the Financial Storm? - TIME
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How Will China Weather the Financial Storm?
By Michael Schuman Thursday, Oct. 23, 2008Chinese police officers in Dongguan
stand guard on Oct. 17 outside the bankrupt toymaker Smart Union, which laid off
6,000 workers
Tse Ka Yin / EyePress News
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Facebook Yahoo! Buzz Mixx Permalink Reprints Related When the global financial
storm began to gather a year ago, China appeared to be a nation that was well
supplied with raincoats. The economy was growing at double-digit rates, Chinese
banks had little overseas exposure to the credit crisis, and the country's $1.9
trillion in hard-currency reserves stood as a vast emergency fund that could be
drawn upon in the event of trouble. Just two months ago, while giant Wall Street
and European banks were crumbling, China was relishing its role as host of the
Olympic Games as the world paid tribute to its years of remarkable, seemingly
unstoppable economic progress.

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The raincoats, it turns out, have holes in them. With the chances for a global
recession increasing, it's becoming clear that not even the world's
fastest-growing major economy can avoid a pronounced slowdown. Any remaining
hopes to the contrary were dashed recently when China's National Bureau of
Statistics released the country's latest economic data: in the third quarter,
GDP growth had slipped to 9%, the slowest quarterly pace since 2003. Meanwhile,
estimates for 2009 growth are being slashed to as low as 8%, which would be a
dramatic deceleration from last year's 12% rate and would rank as China's worst
results since 1999.
It's pretty clear why China is hitting the skids. The country's economic
transformation over the past 25 years has led a great wave of globalization
during which the mainland's once small and isolated economy became much bigger
and deeply integrated into global commerce — making it more exposed to the
business cycles of its big trading partners like the U.S. "The huge elephant in
the China shop is the slowing global economy," says Merrill Lynch Asia economist
T.J. Bond, who cites an obvious reason: China's manufacturing sector, which
accounts for 43% of China's GDP, depends heavily upon sales to the West. Some
40% of China's exports go to the U.S. and Europe, and with potentially deep
recessions setting in there, economists are slashing the country's trade
projections. Bond estimates that China's export growth rate will fall to 10% in
2009 from 21% this year. For the revved-up mainland, that's a frightening
plunge.
A slump in exports has pretty grim implications for the country's manufacturing
boomtowns, and the pain is already being felt. Stanley Lau, deputy chairman of
the Federation of Hong Kong Industries, estimates that export orders at some
70,000 factories owned by Hong Kong companies in southern China have declined
5%-10% this year compared with 2007. Recent months have seen a first wave of
bankruptcies and closures among the tens of thousands of factories in industrial
zones from Guangzhou to Shanghai that make toys, jeans and PCs bound for U.S.
retailers.
Chinese manufacturers are particularly vulnerable to a recession right now
because of higher labor and commodities costs and because of the simple fact
that China's boom resulted in the creation of far more factories than global
demand could possibly support in a cyclical downturn. A shakeout is unavoidable,
and it is being made worse by the worldwide credit crunch. Nervous banks, Lau
says, have reduced the credit lines of many small manufacturers by up to 50%,
starving them of operating funds. Letters of credit, which facilitate the
shipment of exports, were once automatically accepted by banks in Hong Kong, but
now they are being held until bankers are sure funds are coming from overseas,
so payments to manufacturers for their products are being delayed. As a result,
Lau says he expects that 20% of China's Hong Kong–owned factories, which employ
10 million people, could be shut down by early next year. That's a big concern
to government officials, who will be hard-pressed to cope with a growing army of
newly unemployed migrant workers. When Hong Kong toymaker Smart Union abruptly
closed its doors in mid-October, hundreds of angry ex-employees crowded outside
its shuttered factory in Guangdong province demanding unpaid wages. Says Lau: "I
worry that the situation can't be improved."
With global growth expected to slow further in coming months, the pressures
facing manufacturers certainly will increase. Some Chinese companies are giving
up their export businesses entirely. Shi Junmin, CEO of Pinghu Mingda Bag and
Suitcases Co. in Zhejiang province near Shanghai, had been selling suitcases to
U.S. customers since 2006. He stopped in June. Orders were still flowing in from
America, but clients, strained by the financial crisis, were not paying him, Shi
says. By midyear, he says, he was owed some $3 million. Shi instead shifted to
manufacturing luggage for local China brands, hoping domestic sales could rescue
his company. "We just ran out of money to buy materials to manufacture our own,"
Shi complains. "Processing for domestic factories is our only option."
Counting on Chinese consumers, however, may not be a sure bet. Some economists
had thought that increasingly wealthy Chinese, with their appetite for cars,
mobile phones and Big Macs, could help fill the breach opened by retreating
American spenders. But that hope, too, is fading. Though Chinese spending is so
far holding up — retail sales of consumer goods jumped 23% in September —
household consumption, at only 40% of GDP (compared with about 65% in
industrialized countries), isn't yet substantial enough to maintain China's high
growth rates. "I don't think [domestic spending] will replace what has been lost
in exports," says UBS economist Wang Tao. Nor will it offset another weakening
pillar of China's economy: real estate. Rampant construction of new office
towers and apartment blocks in recent years was a huge boon to growth. But
government action to cool down the market, by, for example, restricting credit
for property development, is resulting in a sharp falloff in construction. After
35% growth in real estate investment in the first half of the year, Wang
estimates that growth dropped sharply to some 20% in July and August. The
property sector accounts for about a quarter of all fixed-asset investment in
China and about 10% of national employment. A slump could drag down other
sectors like steel production. "Beijing cannot afford a collapse in the housing
market," wrote Jing Ulrich, chairman of China equities for JPMorgan, in a recent
note to investors.
The Chinese government has quickly awakened to the threat of a sharp slowdown.
Until a few months ago, Beijing's top priority had been fighting inflation. Now
policymakers are easing off the brakes and hitting the gas again in an effort to
stimulate growth. The central bank lowered its benchmark interest rate twice in
the past 45 days, the first cuts since 2002. In mid-October, the State Council
announced plans to increase infrastructure spending, to offer tax rebates for
exporters and to boost government-controlled prices for agricultural products.
Beijing is also widely expected to introduce measures to resuscitate the
faltering property market, in an attempt to prevent a U.S.-style crash in home
prices. The government announced on Oct. 22 that it would waive taxes on certain
property deals to spur flagging sales.
Government action could shield the Chinese economy from the worst of a global
slump. Indeed, economists currently say China ought to remain a relatively
bright spot amid the economic gloom. Merrill Lynch estimates that China will
account for 40% of world GDP growth in 2009. Continued strong Chinese demand for
raw materials, machinery and consumer goods is expected to prop up other Asian
economies — the region as a whole is projected to dodge a recession next year.
But even when growing at a double-digit rate, China's economy is not yet large
enough by itself to keep the global economy surging. The country accounts for
only about 5% of total world GDP; the U.S. is responsible for 28%. "China's
strength can help," says UBS's Wang, "but it's not enough to save the world."
China may be lucky just to save itself.
— With reporting by Lin Yang / Beijing
(Click here to see photos of life on the fringe in China.)

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