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Feeling the pain of China's slowdown

Publication Date : 09-09-2012


Little doubt remains that China's economy is finally slowing down after three years of growing at breakneck speed.

The mainland's economy grew 7.6 per cent in April to June, from the same period last year.

While this may seem high by the standards of most countries, China's second-quarter growth was its slowest since March 2009, at the depths of the last recession.

Back then, the economy expanded 6.2 per cent.

Official policy is part of the reason for the slowdown. Beijing has been keen to control inflation and orchestrate a "soft landing".

But the latest manufacturing figures are increasingly pointing to a slowdown that has taken on a life of its own, largely because of external factors. Key export markets in the United States and Europe are simply not growing.

Given this slowdown, many investment banks have started to cut corporate earnings forecasts for Chinese companies and companies elsewhere with strong exposure to the mainland.

Goldman Sachs chief growth markets strategist Christopher Eoyang summed up China's performance aptly when he said: "The long-term prospects are still bright. It's the short term that we are worried about."

But for investors here, how big an impact will the slowdown have on equities, commodities and currencies?


Chinese equities have been underperforming the rest of the Asian market despite the large amounts of inflows into the region.

The Shanghai Composite Index was close to the 6,000-point mark at its height in 2007, before the financial crisis, but has since fallen to around 2,000 points in recent months.

It rose 3.7 per cent on Friday to 2,127.76 points.

Head of equity research for Asia at ABN Amro private bank, Ms Daphne Roth, said that the sluggish performance could persist for the next few months.

A big reason is that corporate earnings have slumped in the latest quarter of reporting. Net earnings across the board have fallen for the first time since 2008, she said.

In the very short term, the market could get a fillip from central banks in Europe and the United States as policymakers try to stem the fall in confidence.

The Shanghai Composite Index jumped on Friday after the European Central Bank promised to embark on "unlimited" bond buying to restore confidence in embattled European countries.

"You could get a short-term rally from QE3 but beyond that, people will still be looking at fundamentals," Roth said.

QE stands for quantitative easing, and QE3 is shorthand for a third round of stimulus.

Eoyang said that emerging markets such as China and India are unlikely to outperform. "If the global economy continues to teeter but not fall, it may be difficult for emerging markets to significantly outperform, especially as it looks as if the global economy has transitioned into a contractionary phase."

Roth is pessimistic about sectors such as commodities and consumer goods, noting that margins are being squeezed by rising wages. She is, however, slightly more positive on financials.

NRA Capital executive chairman Kevin Scully said sectors driven by external demand, such as shipbuilding, electronics and commodities, will be affected.

"But firms with a domestic demand bent such as China Animal Healthcare may do better," he said.

A lot will also depend on how China's political transition, which is to take place at the end of the year, turns out. President Hu Jintao is due to step down after 10 years in the top job.

"As with many countries, firms with the right political connections will get ahead. But those which don't may end up losers," Mr Scully said.

"Right now, there is a lot of uncertainty over the politics of the situation."

Already, funds are flowing fast out of emerging markets such as China. Barclays reported emerging markets dedicated equity funds saw US$1.8 billion of outflows for the week ended September 5, according to data tracked by EPFR Global.

"These outflows were attributable to sizeable outflows from Chinese and Taiwanese funds, which we interpret as a negative response to the counter-seasonal declines in China's manufacturing data," said Barclays.

But HSBC believes that any further falls from here on will be limited, noting that the lower earnings reported so far had been expected.

"The destocking process, export headwinds and high leverage weigh on profitability, but margins are stabilising," said HSBC in a note.

"We expect earnings growth to stabilise and rebound, as policy-easing measures filter through."

Scully also pointed out that valuations of Chinese firms have dropped significantly over the past two years, bringing the market in line with the rest of the world.

This could mean a buying opportunity for investors keen on the China market.


To grow its manufacturing base, China has been feeding the industrial sector's insatiable appetite for raw materials.

But with the slowdown in economic growth and demand, inventories and stockpiles of industrial metals such as steel and coal have started to build up.

Part of the reason for this is that steelmakers are unwilling to shut down, said Goldman Sachs analyst Julian Zhu.

He said that during a recent visit to China, many steelmakers told him that they were losing money but continued to produce steel as shutting down would mean creating unemployment.

"Many local governments have also started to give energy subsidies to keep them afloat," he said.

As a result, steel prices are at multi-year lows and expected to remain so in the next few months.

The oversupply of steel in China is also likely to mean less demand for coal, which would hit Indonesian and Australian firms supplying raw materials to China.

Indonesia's coal exports to China slumped 16 per cent in July from a year earlier, the first significant fall this year, although in the year to date they are still up more than 15 per cent.

This means prices of coal, steel and even aluminium are likely to remain weak, he added.

On soft commodities such as agriculture, the outlook is also dim although less grim.

Maybank Kim Eng analyst James Koh said that much of the weaker performance from the commodity firms listed in Singapore is probably related to China's slowdown.

"Similar to the last quarter, most of the earnings weakness appears to be traceable to China, the incremental driver of commodity demand," he said.

Of the three big plays in Singapore, Wilmar, Olam and Noble, Mr Koh prefers Noble for its diversified business.

"We see an earnings recovery story in the current financial year, as well as a more diversified portfolio from energy to agriculture," he explained.


The slowdown is likely to have a major impact on both the Chinese yuan and the Australian dollar.

The slower growth outlook will probably mean declines in both currencies.

The yuan has seen some depreciation over the past year and is likely to stay weak for the foreseeable future, said Credit Agricole economist Dariusz Kowalczyk.

He noted that with the slowdown, the emphasis has moved away from inflation to growth concerns.

This has, in turn, led the Chinese central bank to shift its yuan exchange rate policy towards depreciation to support the country's exporters.

"The central bank used to push for yuan appreciation to combat inflation and rebalance the economy," Mr Kowalczyk noted.

"However, external position is much better balanced now, while inflation is no longer a threat."

Similarly, the Aussie dollar is prone to further bouts of weakness should the Chinese economy decelerate further.

The Australian mining boom has been the main reason its economy has held up so well despite the external growth slowdown thus far.

But with iron ore and coal being stocked up and held at Chinese ports, it is only a matter of time before the Australian economy also feels the heat.

The Reserve Bank of Australia recently said that the current resource-led boom could be peaking in one to two years.

Maybank foreign exchange analysts noted that there is still likely to be weakness in the Aussie dollar against the US dollar given the external economy.

But they added that for the Aussie dollar and the Singdollar pair, a short-term rally could be possible, as the pair is trading at "oversold" levels.

The Aussie dollar traded higher against the Singdollar on Friday, rising to S$1.28.


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