MARKET PERSPECTIVE

By J Mulraj

Jan 27- Feb 2, 2024

Problems in the world’s #2 economy can affect global growth

At $ 17.5 trillion, China’s 2023 GDP is second only to USA’s, which is, on an annualized  basis, $ 26.5 trillion. With 28.4% of global manufacturing capacity, with exports of $ 3.3 trillion and imports of $ 2.5 trillion, making it a major trading partner, the economic fate of China matters for global growth.

Hitherto, real estate has been one of the main props to China’s economic growth, accounting for 30% of its GDP. The other main props were (a) Exports and (b) Manufacturing, which included large foreign companies that, looking to its huge population, set up manufacturing bases in China to cater to the huge market.

For several years these props ensured a supercharged economic growth. Chinese citizens invested most of their savings in buying a house, a prerequisite for getting married, and to get rich quick. In the early stages property prices rose sharply. But it was a Ponzi scheme, which has collapsed.

As per this article in Sep 23 issue of FORTUNE, there are some 75-80 m. unsold apartments in China. In 2021 a total of 13.7 m apartments were sold in China, the highest number before sales dropped. So unsold stock would take 6 years or more to clear.

A lot of realty companies took on huge debt, from foreign and from domestic lenders. Last week Evergrande, one of the largest Chinese realty companies, was compelled by a court in Hong Kong, to file for bankruptcy as it has over $300 b. in debt. This will have several consequences.

Foreign investors, holding bonds of Evergrande, are unlikely to get anything; the Chinese Government would seek to give owners of undelivered flats, the first priority. The group has hundreds of subsidiaries, setting up new ones for each construction project, and the bankruptcy process will likely take years.

So foreign portfolio investors, who had been dying to enter the Chinese dragon, will want to now exit the dragon.

So, too, will foreign direct investors, those who set up manufacturing facilities. After Covid hit Dec 2019, and China followed a zero tolerance policy, prohibiting workers from going to work, foreign companies realized how vulnerable their supply chains had become. Several large companies, like Sony, Samsung, Apple, Dell and others have moved from China, or plan to).  South Korean automaker Hyundai just sold its last plant in China.  A survey by the European Chamber of Commerce in 2023 found that two-thirds of the 590 companies that responded stated that doing business in China had become more difficult. The offices of US Consulting firm, Bain & Co, were raided for the normal market research activities they were conducting, and a new anti espionage law passed by China in July 2023 further undermined business confidence.

So, several foreign manufacturing companies have, or plan to, exit the dragon. This has led to high levels of youth unemployment. It has also hit exports.

So the three props of China’s economy, realty, manufacturing and exports, are weakening. China is transitioning to a more domestic driven economy, and to productivity gains led by technology.

It’s technological skills were recently demonstrated by the successful flight of a prototype 4 setter hydrogen powered plane.

In India the Finance Minister, Nirmala Sitharaman, presented her sixth consecutive Budget. There is a welcome trend in her budgets of no tinkering with tax rates and exemptions. That is how it should be. A budget should give revenue and expenditure estimates, outline the vision of the Government, and show the path it is taking to reach it. That is what is being done, kudos to her. She, and the Government, has not succumbed to giving large sops in an election year, as sops to get re-elected. Fiscal prudence has been maintained, though not enough to please a dyspeptic Moody’s to review India’s rating upwards.

The FM, and the Government, is inimical towards cryptocurrencies, like bitcoin. The underlying technology behind bitcoin is blockchain, which is a secure, digital ledger that can record transactions, like land records, without the ability for anyone to tamper with the records. Banning bitcoin without adopting blockchain is like throwing the baby out with the bath water. Possibly, the polity does not want land records to be transparent, to enable them to use ill gotten lucre as a means to whitewash it. One hopes that this Government is sensible enough to allow the use of blockchain to maintain important records in a manner that cannot be altered by an official with greasy hands.

Globally, investors were expecting central banks, led by the Fed, to start cutting rates. But both the US Fed and the Bank of England kept rates unchanged, wanting to wait to see inflationary trends before embarking on cuts. The economic travails of China, mentioned above, can lead to supply chain constraints and, along with the attacks on cargo ships by the Houthis, cause product price inflation. Add to that the sudden executive order signed by Biden, under which new export shipments of LNG are suspended for 15 months, pending environmental impact!

It was the US which egged its partner, the EU, to stop importing Russian oil/gas, guaranteeing it alternative (and five times more expensive) LNG from USA. Now, with this executive order, the EU is left high and dry. The ludicrousness of the decision to stanch Russian energy flow to EU is exposed in its two consequences. One, EU, after buying expensive energy elsewhere, has been economically weakened, and Germany, its strongest economy, is in recession. Two, by egging NATO to turn a deaf ear to Russia’s plea to not admit Ukraine, seeing that as an existential threat to it, Biden has succeeded in making Russia and China, its two foes, come closer together.

Biden’s motive for this action is unclear and certainly not a concern for the environment. The blowing up of the Nordstream pipeline hadn’t seen an outrage from him of harm to the environment by the release of methane gas it caused.

The stoppage of export of US LNG for 15 months will drive up prices, as the importing countries, including India, scramble to buy from other sources. The resulting inflation would delay the easing of the interest rate cycle.

Last week the BSE Sensex closed at 72085, up 1385 points over the week.

Investors should watch out for how China handles its challenges, and geopolitical developments such as how the disruption of commercial traffic in the Red Sea is resolved, how the Israel-Hamas conflict ends and how several elections throw up different leaders. Among all this, a falling interest rate cycle will be the last straw of hope to hold on to.

Picture Source: https://in.pinterest.com/pin/bruce-lee-enter-the-dragon–387591111677543580/

Comments may be sent to jmulraj@asiaconverge.com