By David Rosenberg and Bhawana Chhabra
China, a.k.a. “the growth engine of the world,” has posted a series of disappointing economic data points over the last few months.
The string of misses on retail sales, purchasing managers index, gross domestic product, exports, industrial production, etc., came in despite a low base being owed to one of the longest-standing COVID-19 restrictions in the world, which was finally lifted last year. Hence, not so surprisingly, all hopes were pinned on “revenge consumer spending,” as was seen everywhere else in the world.
But there have been headwinds: continued slowdown in property prices is making the Chinese consumers feel poorer, and urban youth unemployment — at a whopping high of 21.3 per cent even though overall unemployment remains stable at about 5.2 per cent — is adversely impacting consumption demand amongst the younger cohort.
Though this near-term weakness is prompted by China’s crackdown on the real estate and tech sectors, which has resulted in slower consumption, the country is also faced with a more structural “middle-income trap” as GDP per capita has risen, debt to GDP has almost tripled over the past three decades and the growth rates have come off.
Consequently, we believe the slowdown in the Chinese economy is not merely tactical, but is more complex and has wide-ranging implications than what primarily meets the eye. China’s extraordinary export-led growth has been driven by becoming a low-cost production powerhouse, but drivers for this kind of growth are waning.
Three China headwinds
Going forward, there are three headwinds that would keep the high growth trajectory capped.
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First, the high overall debt-to-GDP ratio (at 297 per cent, it has almost tripled over the past three decades) will keep the government’s capacity for fiscal stimulus limited, implying China cannot turn to the playbook it used during previous downturns such as the one seen in 2008 when it announced a massive stimulus package worth four trillion Chinese yuan (US$586 billion at that time).
Second, a shrinking and aging labour force (average age of the labour force is now 39 years versus 32 in 1990) has pushed wage costs higher. Consequently, southern neighbours in Asia seem to present more lucrative options for the production of low-cost goods (Thailand’s unit labour costs have risen only 43 per cent since the year 2000 while China’s have about tripled).
And public policy uncertainty has gone up drastically — especially in light of the trade war with the United States, the crackdown on tech, real estate and education tech sectors, and prolonged COVID-19 restrictions — prompting most corporates to diversify their supply chains away from China to the other emerging peers with better labour costs and policy support, culminating in corporate strategies more popularly known as “China plus one” or “friend-shoring.”
Takeaways for emerging market investors
This structural shift in China’s growth story has implications for emerging market investors. There are a few takeaways to navigate these contours.
While the country’s valuations are more amenable as it prices in these risks (the Shanghai composite 12-month forward P/E is at 10.1x), China will not be the secular story it once was, so investment decisions should be more bottom-up and sectoral in nature to avoid the “value traps.”
Owing to supply-chain diversification away from China and policy support from the governments of emerging peers (such as production-linked incentives introduced by India’s government to support the manufacturing sector), emerging economies like India and Mexico will see more macro tailwinds (Mexico recently surpassed China in terms of exports of goods to the U.S.) and this concurs well with our positive call on India and Mexico, which we expect to do well over the next few years,
And, more tactically, the near-term slowdown could put downward pressure on commodity prices, thus implying a negative rub-off impact on Brazil and Australia.
David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. Bhawana Chhabra is a senior market strategist there. To receive more of David Rosenberg’s insights and analysis, you can sign up for a complimentary, one-month trial on the Rosenberg Research website.