1 October 2015, Stockholm, Sweden | News
As the world's most populous country and, since 2010, the largest export nation in the world market, China has a key role in the global economy. Starting in 1978, a previously largely closed communist regime has taken many small steps towards a more open and market-oriented economy in the country as a whole. The standard of living has increased significantly, and parts of China's industry have been completely reformed.
China overtook the United States ten years ago as the leading consumer of wheat, rice, coal and steel. China's GDP growth over the past 20 years has been driven primarily by investment in infrastructure, industry and buildings, and in most cases by positive net exports. The investment phase was almost explosive for a period, resulting in remarkable consumption patterns. For example, China for a while consumed three times as much cement per capita as the US or Europe.
During the past year, fluctuations in the local stock markets in Shanghai and Shenzhen have been dramatic. After a rise of well over 100 percent, for example, the Shanghai index has fallen by about 40 percent since the beginning of June. However, only 7 percent of the Chinese population own shares. This means that the stock market decline of recent months affects a relatively small proportion of China's population and is therefore not expected to have any significant impact on areas such as consumption. The fact that the stock market also performed extremely strongly at the beginning of the year means that only those who purchased shares during a brief period in the first half are the big losers.
Overall debt in China is very high, but among companies rather than among households. The proportion of bad loans is believed to be as high as 10 percent, or even more, of the total debt. That said, both banks and a number of the lending companies are backed by the state, so the risks are within the control of the state and politicians. This does not mean that the risks are smaller, but the system differs greatly from that in the West, where instead much of the risk capital is via listed companies with diversified ownership among both individuals and institutions that manage insurance and pension assets. Even in the Western world, we have fresh experience of the state having to step in as guarantor when risk capital was insufficient to deal with a major credit crunch in the banking system. Thus, the solution during a crisis does not appear to differ much between the different systems; it is the state that must intervene if and when things get tricky.
The weakness we have seen in the Chinese real economy is due partly to falling exports, which are actually determined more by the economic situation of the importing countries. Weakness in the Western world has simply reduced the demand for goods made in China. This has simultaneously reduced the need for the importation of inputs. Meanwhile, China previously introduced certain limitations in the domestic economy to curb excessive speculative elements in the real estate market. Real estate is the most important form of saving in China since, given the current level of inflation, savings accounts offer no positive real return and the stock market, with its historical volatility, only attracts a small part of the population. Individuals who have amassed large private wealth have therefore often bought multiple residential properties for rental, in order to obtain some return on their money while protecting their capital against inflation. From a multiannual perspective, this has sharply driven up the prices of private accommodation, and many investors have bought not just one or two homes, but several. This in turn has fuelled the construction of new housing and driven demand for all the input goods, like steel, cement and metals. China eventually introduced restrictions, such as through higher mandatory deposits for homes and higher staged deposits according to the number of homes that were bought. For some time, the country also raised the general level of interest rates and reserve requirements for banks, all to curb the trend. With the usual lag, real estate prices first started to level out and then fell, and the construction of new properties slowed. In 2015, however, the authorities started to backtrack on several of the previously imposed restrictions as the economy weakened generally, in order to offer a little more support to the market. The mandatory deposit has once again been lowered and both reserve requirements and the policy interest rate have been cut.
This whole cycle has meant that China today has large excess capacity in its steel and cement industries. It was certainly not only the construction of private homes that drove this industrial investment, but also large infrastructure projects during the global crisis of 2008/2009, when China made huge investments. When demand then fell back, there were brutal falls in the prices of steel, cement and also nickel and other alloying metals used in the production of stainless steel.
Catella examines the market
For the past week, I have been in China as a representative of Catella to meet with a number of Swedish companies, hoping to gain a deeper and more current understanding of the economic cycle. With a bearing on the overall economic development, politics and the real estate market, we met with the local managers of Swedish banks SEB and Handelsbanken, as well as with Standard Charter and Jones Lang LaSalle. In addition, we met with Ericsson and the three major mobile operators, China Mobile, China Unicom and China Telecom. Finally, we met with Alfa Laval and Elekta, which both have large operations and sales in China.
In the telecom industry, 4G is currently being rolled out in China at a furious pace. China Mobile, which has made the most progress, has now reached 85 percent coverage of the population and will, by the end of the year, have a network with a total of an almost incomprehensible 1.08 million base stations using 4G technology. China Unicom currently has around 500,000 base stations for 4G, and is just over 10 percent behind in terms of covered area. The installation rate has been ratcheted up by both China Unicom and China Telecom. In the short term, of course, this drives up sales enormously for companies that supply equipment. Domestic Huawei and ZTE are taking the majority, while Swedish Ericsson is winning around 11 percent of the total order volume for base stations. However, we should pause to think about what will happen when the world's single largest market has completed its rollout. China accounts for more than 40 percent of the total world market. Although a number of countries are in an earlier phase, there will probably be a fall in overall volumes for manufacturers of base stations by next year. In addition, Chinese manufacturers have basically closed the technological gap completely. That said, Ericsson sounded upbeat in the absolute near future regarding the high roll-out rate during the second half of the year, regarding several other Southeast Asian markets and, in the longer term, also regarding India.
The decline in the property market seems to have slowed down thanks to the relaxations that have been implemented. There is still a large stock of unsold properties, but it is no longer increasing. The number of transactions has increased, and prices are rising again in the very largest cities, where demand is by far the greatest.
Both China and the wider region are very important for Elekta. As living standards improve, resources for health care in general and an aging population are increasing, and unfortunately a large proportion of smokers are also driving up the number of cancer cases. Penetration is still well below Western levels when looking at the type of equipment sold by Elekta. In a longer perspective, it is easy to paint a picture of good growth potential for many years to come. However, competition has intensified, primarily from its main competitor Varian, but there are also growing numbers of small local players. It feels like the extremely high growth rates we have seen over the past five years will be difficult to maintain, and price competition is likely to increase in future. Just as with telecom equipment, there are markets in the region that appear more exciting in the short term.
Alfa Laval has significant and broad exposure to China, with everything from the food industry to district heating and water treatment. By far its largest exposure, however, is to the maritime industry, which in plain language means installations on newly built vessels in the form of filters for bunker oil, ballast cleaning and a number of other applications. While many of the former segments seem to be doing really well, the maritime arm has unfortunately been hit quite hard by falling freight rates, which of course are due to falling imports, exports and commodity prices, in turn impacting ship builders in the region. China, South Korea and Japan dominate the global shipbuilding industry. New orders have fallen significantly in several segments of the market. The market is very familiar with this weakness, but Alfa Laval did not sound particularly downbeat. It has a relatively long order book since lead times on vessels of this type can be several years. It has not yet seen any order cancellations, as was the case in previous cycles.
How do we summarise all this information? We must, as always, admit that these are highly complex issues, and we note that the picture is very mixed. Some sectors are doing well (food, some consumption, district heating), while others are quite weak (mining, maritime). Some areas feel clearly overheated (telecoms), while others are improving again (real estate). It is quite obvious that the growth rate of the economy is currently below the official figure, given the data on rail transport and electricity consumption, as well as the anecdotal comments we received. At the same time, we know that the government has a number of tools it can use if things slow down too much.
The journey is unlikely to be straightforward in the coming year, either up or down. But given China's proportion of the world's population, production, imports and exports, this giant will continue to fascinate us for many years to come.
