For years now, investors have been fretting over the expected slowdown in Chinese growth. After all, the 7.5% the country was recently enjoying just cannot go on forever, and the only real question was over the severity of the slowdown. The more bearish observers were expecting a hard crash, with those more optimistic looking for a so-called soft landing — and the reality looks like it’ll be somewhere in between.
We heard this week that September’s factory activity figures suggested the biggest contraction in more than six years — although that’s actually less dramatic than it sounds, as any fall after years of expansion is inevitably going to be the worst for however long it’s been.
Slowing growth
The Chinese government had been aiming for 7% growth this year, but the Asian Development bank has lowered its estimates to 6.8% and Western central banks are resisting interest rate rises as ripples from China are expected to impact on the whole world’s economic outlook. But again, a bit of perspective is needed — growth of only 6.8% is still beyond the wildest of dreams of most of us.
If China’s stock market is anything to go by, we really are in trouble, as it has lost 45% of its value since June. But again, that’s nowhere near as bad as it sounds, for two main reasons. Firstly, listed companies account for far less of China’s GDP than in Western nations. And secondly, it was a politically manipulated stock market and had been pumped to unsustainable levels — it’s almost as if they didn’t learn anything from that Great Leap Forward trick they tried all those years ago.
Structural change
I’m less worried about China than many, yet I’m convinced there is worse to come before things get better. The real problem is that China is trying to move away from massive state-owned enterprises that drive growth, to a freer market of private enterprise — but at the same time, the Party still wants to control everything and won’t let go and leave it to market forces.
State enterprises are horribly inefficient compared to private business, as just about anyone with any experience of the world in the past century would expect. In fact, returns from some of them aren’t even enough to cover their cost of capital, but the banks are obliged to keep rolling over their loans and aren’t allowed to pull the plug.
And so the banks are building up toxic debt, and if China’s economy were to be fully opened and free tomorrow, a string of collapses of state enterprises could precipitate a financial crisis that would dwarf the one we’ve just experienced here in the West.
The market will win
Of course, that won’t be allowed to happen, but structural change is going to be harder than feared and it will need to be managed carefully — and delicacy is not a characteristic we’ve come to expect from the Beijing political elite.
But China’s greatest strength is the Chinese people, who have achieved so much this far that there’s no going back. The free market will win out, and long-term investors should have no fear in buying shares in our best FTSE-listed businesses — but the short-term path could be strewn with a few more rocks than many expect.
