December 29, 2011
This time a year ago, GCiS’s managing partner asked a small group of us to think about macro-themes that would have an impact on the economy in 2011. We took these and, with the trends we’d uncovered in the course of our research, tried to come up with specific insights and predictions.
Some good calls were made and so were some bad ones. I won’t go into them because the main purpose of our exercise wasn’t to make a set of specific predictions, but to predict what events could and would influence our modeling. I set up news alerts for the following items:
China Inflation: 3-4% in 2012
In 2011. The subject of numerous posts this year, inflation has been a function of the drought of 2009/10, the creation and existence of around RMB 50 trillion in loans in recent years, and structural constraints. It peaked at an official rate of 6.5% in July before declining to its current level of 4.2%, still above the target of 3.5%. Taming inflation has been a priority for the Chinese leadership, who have rammed a series of control rods into the economy in order to stem the tide. The biggest ameliorating factor, to my mind, has been shut-off of the capital valve, partially due to government controls, but mostly because export orders weakened and investors have realized that they’re not getting anything like the returns they’d expected.
In 2012. We’ll see a continuation of disinflation, settling on a 3% floor sometime in Q2 as the trends I described above continue. Thereafter, I predict that a stimulus package of sorts is put in place, which will drive land values up again. This time next year we’ll be talking about 4% being the new norm for China. It won’t fall below this mark due to the structural reasons I alluded to above. Namely, the concentration of large centralized points of distribution and other factors affecting price stickiness.
China property prices: healthy cooling, no bubble in the first place
In 2011 we saw the continued investment into high-priced property that created historic overhang. The irrational exuberance that characterized the market continued right up until late Q3. Subsequently, well publicized accounts of high discounts in Shanghai and Beijing on said luxury property caused a few people to claim that the China property bubble had burst. But I disagree with this assessment for two reasons: (i) On the whole, China faces a housing shortage. The discounts are localized in the major tier one cities and are for high-price (I’ll define this as that which is priced over 200 times average wages) apartments only, and (ii) discounts on primary sales does not a burst bubble make. The secondary market is still fairly robust – a burst bubble would imply that everyone would be looking to sell their apartments, and that just isn’t happening.
In 2012, construction will continue to slow. We’ve been seeing this for months, the canary, so to speak, has been construction machinery sales, which have been poor since the summer. The construction of low cost housing, which we expect will commence in H2 2012 in earnest will push this up a bit. Outside residential, I see commercial developers loosing money on the build-it-and-they-will come routine. Those with genuine draw (possibly like the soon to be opened 798 mall here in Beijing) that can get the foot traffic in will do better. Industrial construction will move to Central and Central West China.
China Price controls: easing in non-strategic areas
In 2011, these were used to a more moderate extent than we’d feared, showing that the government was able to pull most of the macroeconomic levers it needed when it needed them.
In 2012, price controls will ease. Key strategic controls like energy and politicized controls will remain in place for 2012 and at least until after 2013.
Currency war: time for a hackneyed phrase to retire
In 2011 this turned out to be a bit of a non-starter. The USA did not launch QE3, nor did it label China a currency manipulator and China’s trade surplus with the US fell.
However, in 2012, there are some reasons to think that this, admittedly political/marketing term, will be back on the stage. Presidential candidates in the US need to have some “what we’re going to about China” spiel. In the upcoming primaries, it will be at it most hawkish, easing by the time each party gets behind a candidate and they have to raise funds from the corporations and funds with much to loose from diplomatic discord. The complexities of what constitutes currency manipulation (arguably, all major economies are at it) will see this phrase dropped by the press.
Eurozone debt: guilt-edged securities
The eruption from Europe’s monetary imbalances has been long overdue. In the first half of 2011 it quietly smoldered while other shocks such as the Japanese earthquake and the revolting Middle East commanded the market’s attention. Shortly after a correction in global equities markets in early August, the spiraling costs of debt in all Eurozone countries, including Germany, have threatened major disruptions to the goods markets. At the time of writing, core and periphery EU members are being asked to flesh out a treaty that would see further fiscal integration. The UK, sensing an “unequal treaty” has opted out, meanwhile the ECB will fund half a Trillion EUR in refinancing, further consolidating the responsibility for fiscal management to a single entity and taking another step along the road to a Eurobond.
2012 will be a year of long hard slog for EU leaders. I don’t expect any of the drama of 2011: Greece will stay in and the Eurozone will go into recession for most or all of 2012. Euro periphery countries like Britain will be on stall speed. This will impact China in at least two ways in 2012 (i) exports to the Eurozone will weaken; and (ii) protectionism in the Eurozone will increase.
China Infrastructure Building: China Inc’s grip will tighten
In mid 2011, I hiked to the summit of Ling Shan, the highest mountain in the Beijing region (2,300m). Being carved through the stunning landscape below was a six lane highway. Lingshan is in a sparsely populated area, unsuitable for farming and already served by multiple national highways. Why was it being built? Primarily because the money to do so was cheap and it raises the value of the land; subordinately because in 10-15 years’ it may be needed.
This embodies much of the approach that China Inc is taking to investment; namely, borrowing from future demand. But two consequences are going to felt keenly in 2012. First, supply to future demand is becoming saturated; and second, the state sector is ballooning in proportion to the private sector. SOEs like to do business with other SOEs, and in doing so, are crowding out foreign and private participation from the supply chain. This may seem fairly innocuous in the case of a road, which is built by governments in most countries, but infrastructure building by China Inc is crowding out in sectors like energy and heavy industry, and will further crowd the sectors that have been earmarked in the five year plan. Foreign players will have some recourse through their embassies (provided ties are cordial, as discussed above), but domestic players will be pushed into a weak export-facing role. Will the expanding state sector soak up the unemployment from the private sector?
This brings me nicely to the news alerts I’ll be setting in 2012.
This issue is going to drive increased pressure on FIEs to localize. We saw a bit of this with the social welfare fund that expats have to pay into and there are going to be further measures to make it harder to fire people. Chinese companies may see hiring quotas, or will further their use of headcount as a statistic to curry favor / win government contracts etc.
China local government debt
Government loans in 2011 were actually less than the projected RMB 7.5 trillion. Nevertheless, the central government will probably end up “doing an ECB” interest carry and will, IMO, exceed RMB 8 trillion in 2012.
China interbank lending
Some form of financial reform is going to happen this year. It will start with greater autonomy for local banks and will also aim to encourage more interbank lending.
China low cost housing
As mentioned previously, affordable housing is the next Big Project for China Inc.
China domestic investment
While domestic investment is down, mostly because of overinvestment but also because of the unpredictability of China’s capital markets, a couple of trends will be worth looking out for: first, delisting in the USA and relisting in Hong Kong or the Mainland; second SOE equity sales to Chinese citizens.
I see GDP growth of 5-6% in China for 2012, a soft landing for the economy. The drop off in exports will continue to hurt and there will be no 2009 style Marshall Plan to boost growth. A stimulus package for the poor will be rolled out. Stock market up.
So there you have it, predictions for 2012, which are my views and not necessarily those of GCiS. Y’all have a happy new year.
About GCiS China Strategic Research
GCiS (www.GCiS.com.cn) is a China-based market research and advisory firm focused on business to business markets. Since 1997, GCiS has been working with leading multinationals in sectors ranging from technology to industrial markets, medical, chemicals, resources, building and constructions and a few others.