GDP growth in mainland China could collapse to between 3% and 5% come 2007 says CLSA's distinguished chief economist Dr Jim Walker. The figure, which he revealed at CLSA's China Forum this week, visibly stunned an interview room full of Chinese journalists given how much lower it is than official government pronouncements.
Conventional wisdom states that any drop in growth below 7% would cause social collapse in China, since unemployment from restructuring would be growing faster than new business. The upshot of such a scenario could be buy-ins by foreign multinationals, which would make the acquisitions made in Thailand and Korea post-1997 crisis look like a car boot sale.
"There will be huge opportunities for MNCs," Walker said, adding how uniquely pragmatic the Chinese government is by Asian standards when it comes to putting economic prosperity above nationalism.
Foreign-invested firms currently contribute to over half of China's exports by value and one third of industrial output. Those opportunities would be underpinned by a government desperate to counteract the economic down cycle by bringing even greater foreign direct investment than exists at present. China received more FDI last year than any country in the world.
Walker does not believe that the Chinese government would seize the opportunity to introduce wholesale nationalization of the economy. "China is already too far along the path of capitalist reform," he asserted.
He estimated that China's slowdown will start this year, dropping to around 8% and slow even further next year, before falling off a cliff in 2007. "There is an excess of money and too few investment opportunities, meaning more and more money is going into speculative areas such as property," he commented.
On the back of these serious overheating concerns, government economic policy will have a tightening bias, even in the face of an economic slowdown.
"Interest rates will rise and the exchange rate will adjust," he argued, although he does not expect the exchange rate adjustment to be major. He said it will be impossible for China to continue growing at its current rate of 9% to 10%. In fact, he believes the country is about to go into its first capitalist cycle.
The main reason will be a major drop in corporate profitability, especially in the private sector, as a result of soaring commodities prices and cut-throat competition.
According to CLSA figures, A share listed companies saw their net profit margins drop from 6.5% in Q1 last year to 3.5% in the fourth quarter, while net profit growth collapsed from 44% in Q1 last year to 14.7% in the final quarter.
This will mark China's first true capitalist cycle because it is the first boom generated off the back of the private sector. China's earlier boom in 1992-94, which led to a massive bust in the mid-90s, was driven by the state-owned enterprises and banks.
However, when the constitution was changed to acknowledge private property two years ago, the country saw a huge burst of business activity.
"When we speak to companies now, they tell us that they have thousands, not tens or hundreds, of competitors," Walker said. This kind of rapid business formation is normal in early-stage capitalist economies he noted and it normally leads to vanishing profits.
The downturn will be exacerbated by banks ceasing to lend to private companies which show declining profits. At that point, companies start laying off staff, leading to rising unemployment and an exacerbated downturn as consumption is hit.
"Previously, Chinese banks continued to lend even in a downturn, but that was to SOEs, with a government guarantee. Once private companies start encountering difficulties, banks will cut off cash flows," he said.
The role of the private sector is controversial, with no accurate statistics about its contribution to the economy. A conventional estimate is that the private sector contributes to at least half of non-agricultural GDP.
However, Walker said that growth is a marginal concept. That makes the private sector a key component, since it generates most of China's growth, even if in absolute terms it is not the biggest component of the economy.
But Walker said such a scenario is by no means 'apocalyptic' in the words of one journalist at the press conference.
"Thailand's GDP contracting by 10% in the Asian Financial Crisis was apocalyptic, not a slowdown to 3% to 5% as in China," he asserted.
The Chinese banks would not necessarily suffer a massive hit from a collapsing private sector, because they are not greatly exposed to the private sector he continued. They are more exposed to the public sector, but the public sector has been one of the major beneficiaries of the private sector boom in terms of new customers. Therefore, SOEs are not especially highly leveraged by historical standards.
Comments by Wen Tiejun, deputy secretary general of the China Foundation for Macroeconomic Study who also attended the forum, indicate that selling off assets to foreigners could be the least of the government's worries.
Wen pointed out out that the wealth gap between cities and urbanites, coastal provinces and inland provinces, is worsening. Urban workers' annual incomes are six times as high as those in the countryside, and China's Gini coefficient (the index for measuring wealth inequality) has increased to 0.46, compared to 0.30 in 1980, showing increased inequality.
This inequality is getting worse as rural workers are pushed off the land by real estate developers. That increases the amount of migrant labour, estimated at some 300 million. Yet already industry capacity is showing a surplus, with more than 70% of industrial products currently over supplied. That means an increasingly large pool of disposessed peasants is being created, which the system is unable to provide with work.
Walker's and Wen's comments will be especially unwelcome for the mainland government since the gloomy scenario they predict will be just ahead of the 2008 Beijing Olympics.
