The benefits and perils of riding China’s

coat-tails
By David Pilling

Many Latin American nations have bet the mine on an economy that is now slowing

Few parts of the world have benefited as much from China’s rise as Latin America. In 1990,
China was a lowly 17th on the list of destinations for Latin American exports. By 2011, it had
become the number one export market for Brazil, Chile and Peru and number two for Argentina,
Cuba, Uruguay, Colombia and Venezuela. Over that time, annual trade rose from an
unremarkable $8bn to an irreplaceable $230bn. Chinese leaders predict it will reach $400bn by
2017.

As China builds its colossal cities, constructs its networks of highways and railways, and feeds
its evermore carnivorous people, Latin America has much of what it takes to keep the show on
the road. Chilean copper, Peruvian zinc and Brazilian iron ore are being shipped in vast
quantities. The region is the Middle East of food, accounting for 40 per cent of global farming
exports. It supplies water-poor China with dizzying amounts of beef, poultry, soya, corn, coffee
and animal feed. If Chatinamerica rolled off the tongue as easily as Chindia or Chindonesia,
someone would have coined the term long ago.

The speed with which economic relations have flourished raises two important questions equally
applicable to other parts of the world. First, what happens when Chinese growth and investment
slows, a process that has already begun? Second, how can Latin America forge an economic
relationship that is more than just a rerun of its commodity dependency of eras past?

To work out what might happen as China slows, we should first look at how different countries
fared as it took off in the 1990s. As Alfredo Toro Hardy, a Venezuelan academic and diplomat,
makes clear in his book, The World Turned Upside Down, there were losers as well as winners.

Broadly, the losers were Mexico and the “Mexico-type economies” of Central America with
low-cost maquiladora plants for assembly and manufacturing. For Mexico, a net importer of raw
materials, including corn and soya, the rise in commodity prices accompanying China’s ascent
had a largely negative impact. More important, as China’s manufacturing prowess grew,
Mexico’s factories lost competitiveness. From 2001 to 2006 its share of US personal computer
imports halved to 7 per cent. Over the same period China’s share more than tripled to 45 per
cent.

The winners were Brazil and the “Brazilian-type economies” of South America. Not only did
China vastly increase its imports of commodities from the likes of Peru and Chile but the
commodity supercycle also pushed prices of raw materials to record highs. Kevin Gallagher and
Roberto Porzecanski estimate in their book The Dragon in the Room that three-quarters of recent
Latin American growth can be attributed to commodity exports. Growth rates in countries with
the tightest trade links to China reached a rough average of 5 per cent.

Yet even during the bonanza years, now ending, there were concerns. Cheap Chinese imports
undermined Latin American manufacturers even in countries such as Brazil with a sophisticated
industrial base. The currencies of commodity exporters appreciated – a classic case of “Dutch
disease” – making their manufactured goods still less competitive. Some, such as Mr Toro
Hardy, worried that over-reliance on commodities might imply “going back in time” to a primary
export economy. For a high-technology producer such as Brazil, he said, this smacked of neo-
colonialism.

Such concerns, though they have particular resonance in Latin America, apply to other countries
that have ridden China’s commodity train, from Australia to Mongolia. Many countries have bet
the farm – or rather the mine – on everlasting demand from a China whose economy is now
slowing.

As China decelerates from double-digit growth to a projected 7.5 per cent this year, the
economies of some commodity exporters have stumbled. Brazil is a case in point. Partly as a
result of slowing exports to China and falling commodity prices – copper, iron ore and coal are
30-50 per cent off their 2011 peaks – it registered average growth of just 1.8 per cent in 2011 and
2012, down from a roaring 7.5 per cent in 2010.

That process could have further to go. China’s economy may slow more sharply than expected or
it may rebalance more quickly from investment-led to consumption-driven growth. The
Economist, perhaps prematurely, has already declared a structural “Great Deceleration” in
emerging markets. In a report entitled If China sneezes, Nomura estimates the impact on several
economies if 2014 growth in China’s $8tn-plus economy slips 1 percentage point below
Nomura’s baseline forecast of 6.9 per cent. It finds that a 1 point fall would shave a further half-
point off Latin American growth. Some countries such as Australia, down 0.7 per cent, and
trade-dependent Singapore, down 1.3 per cent, would fare worse.

It is not all bad. Mexico may actually have benefited from the changing nature of China’s
economy, where higher wages have breathed new life into the maquiladora system. Nor has it
suffered from the fall in commodity prices.

Even in countries such as Brazil, the effects of a Chinese slowdown need not be all negative.
China will continue to urbanise, putting a floor under metals prices. To the extent that its demand
for hard commodities does slow, its appetite for meat and grains should rise. The key for Latin
America – and for other suppliers of China’s needs – is to construct a trade relationship that
maximises value added, even if that is only branding or processing raw materials. Canada,
Australia and, closer to home, Chile show that being a first-rate commodity exporter does not
necessarily mean having a second-rate economy.

July 23, 2013 8:17 pm

China: Slower but steady

By Chris Giles, Economics Editor

Growth still contributes more to global demand than that of any other economy but rebalancing will
create winners and losers

When is a 7.5 per cent annual rate of economic growth a disappointment? When the economy in
question is China and you have begun to rely on it growing at 10 per cent. That is the conundrum
facing some economies and some areas of business across the world.

The list of potentially vulnerable sectors is long. From Australian mines to German
manufacturers, many companies are learning that selling to China far from guarantees stellar top-
line growth. And in a globally integrated supply chain, disappointment for these exporters is
rapidly transmitted to their suppliers.

As Changyong Rhee, chief economist of the Asian Development Bank, says, “the drop in trade
and scaling back of investment are part of a more balanced growth path for [China] and the
knock-on effect of its slower pace is definitely a concern for the region”.

Concern has spread to the highest echelons of global economic management. In a speech last
week, Christine Lagarde, managing director of the International Monetary Fund, said that for the
global economy as a whole, “there is also a risk that the growth slowdown in emerging markets
could last longer than we expect”.
Stephen King, chief economist of HSBC, says many countries will be vulnerable. “Among the
most exposed are some of the world’s major commodity producers, thanks to recent declines in
commodity prices.”

But even though some countries and exporters to China are squealing, the change in fortunes
should have come as little surprise. For years, the Chinese political leadership has talked about
rebalancing its economy away from investment, exports, building and production towards
consumption. Now we are seeing the first signs of action.

For a long time, Chinese politicians’ words carried little weight because each time growth
slowed, they would enact a new stimulus package and unleash another boom in construction and
investment. But this time it does seem to be different.

Commodities: the supercycle may have ground to a halt but China is such a large consumer that
even slower growth requires a significant increase in supplies. Companies associated with a
consumer economy, such as oil and meat producers, should perform extremely well.


Cars: Car sales in China rose 14 per cent in the first six months of this year, against a 7 per cent
fall in Europe. With only 60 cars per 1,000 people, the potential for growth is enormous and car
companies have poured billions of dollars into the country.

 Manufacturing: German shipments to China fell 7 per cent last year but a survey of 500 German
businesses operating in China found that just 14 per cent predicted worse conditions.
 Luxury: Sales in China rose 20 per cent last year but will slow down to 6-8 per cent this year.
That is still higher than their 4-5 per cent global growth forecast, however. The most important
point for most luxury goods companies is that China has vast potential for producing large
numbers of aspirational consumers.


China’s demand for new roads, railways and homes is waning, while foreign demand for yet
more Chinese goods exports has been satisfied. China has realised that allowing its investment
share of national income to rise from a little over 40 per cent before the financial crisis to a touch
under 50 per cent today has made the eventual rebalancing towards consumption even more
difficult.

Slowing and rebalancing in China might hurt some but the effects should not be exaggerated.
When China started to grow at 10 per cent a year in the early 1980s, its expansion was as
valuable for the world economy as the US growing at 1 per cent. It was nice to have but easy to
ignore. Over a quarter century of phenomenal Chinese growth, if its economy expands by 8 per
cent today, it is the equivalent of the US growing 4 per cent.

A Chinese economy growing at an annual rate of 7.5 per cent, as it did in the second quarter, is
still contributing more to global demand growth than expansion in any other economy. The
slowdown is therefore only a problem for those naively expecting 10 per cent growth to last
forever.

Rebalancing, on the other hand, will generate winners and losers. Those feeling nervous must
include commodity exporters, such as Australia, which has fuelled Chinese construction with its
iron ore. As Prime Minister Kevin Rudd said, his country now faces the end of a decade-long
resources boom so “diversification and productivity are no longer important for Australia, they
are essential”.

But there will be winners, too. So long as China manages to encourage consumption and a
gradual shift towards a larger service sector, producers of other goods and services consumed in
China will benefit.

Andreas Rees of UniCredit notes that even though German car exports to China have fallen this
year, such is the pent-up demand that it is likely to represent a pause in an upward trend rather
than a reversal. “The envisaged rebalancing of the Chinese economy towards more consumption
should lift private households’ appetite for autos even further,” he says.

There are risks along this road to rebalancing. Chinese investment might drop before
consumption picks up the baton, turning a slowdown into a Chinese slump, which would create
losers alone. Such an outcome is possible and, as the IMF recommended in its annual
surveillance mission to China, significant reform is needed to prevent such an outcome.

But is a disaster likely where the whole world is the loser? The consensus is no. Economic
conventional wisdom has an unfortunate habit of being spectacularly wrong in recent years but
almost everyone still agrees that there is little sign that the global economic crisis is about to
have a Chinese third act to follow the US and eurozone, which starred in Acts One and Two.

...
 ©Bloomberg

Commodities

If one sector has felt the pain of China’s slowdown most acutely, it is the natural resources
industry. The country’s stellar growth over the past decade has been responsible for the
commodities “supercycle” in which prices of commodities from cotton to copper soared as
producers struggled to meet ravenous Chinese demand, writes Jack Farchy.

China’s share of global steel demand rose from 16 per cent in 2000 to 44 per cent 2012; in nickel
its share leapt from 6 per cent to 45 per cent.

The impact was dramatic, driving prices of almost all commodities to record highs. But the
market’s growing reliance on China has proved a double-edged sword now Chinese growth is
slowing. Copper, iron ore and coal have all fallen 30-50 per cent from their 2011 peaks. Share
prices of some companies are down more than 60 per cent.

The reality may be less apocalyptic. Even if Chinese growth is slowing, it continues to grow
more rapidly than any other large commodity consumer. And it is such a large consumer that
even slower growth requires a significant increase in supplies. So, for example, 5 per cent growth
in demand translates to an additional 420,000 tonnes of copper consumption.

Beijing’s intention to rebalance the economy away from investment-led growth towards a
consumption-driven model will have mixed implications. The star performers – iron ore and coal
– are likely to be hardest hit. But commodities associated with a consumer economy could
perform well. More car owners would use more petrol, putting upward pressure on oil demand.
Tighter environmental standards could spur greater use of palladium in catalytic converters. And
wealthier Chinese consumers are likely to eat more meat, potentially triggering a boom for meat
and grain producers.

...
 ©AP

Cars

If global carmakers are worried about a Chinese slowdown, three new factories opening in the
past month is a funny way to show it, writes Henry Foy.

Despite anxiety about squeezed credit markets, declining economic growth and rising numbers
of cities considering curbs on car sales, business is still booming in China. Faced with Europe’s
worst sales slowdown in two decades and disappointing performance in other emerging markets
such as India and Russia, the motor industry has poured billions into the country.

PSA Peugeot Citroën opened its third plant this month, in striking contrast to Europe where it is
closing factories and shedding jobs, while Ford and General Motors both cut the ceremonial tape
on new plants last month. Renault is close to signing an entry deal.

“Manufacturers don’t seem to be worried at all,” says Philip Watkins, director of automotive
equity research at Citi Investment Research. “There is still a very large amount of growth
potential in China.”

Car sales in China rose 14 per cent in the first six months of this year, against a 7 per cent fall in
Europe. Chinese sales account for about 35 per cent of European carmakers’ profits, according to
Morgan Stanley research.

But the slowdown in the economy may start to affect spending power, and curbs on vehicle
ownership in big cities in response to emission and congestion worries will inhibit urban growth.

There is still huge growth potential, however. Car ownership is estimated at roughly 60 cars per
1,000 people, far below the EU average of 500 cars.

Perhaps the most comforting statistic for market leaders Volkswagen, General Motors and
Hyundaiis that only about 15 per cent of new cars are bought using finance, meaning dealers
should be insulated from any credit crunch.

...
 ©AP

Manufacturing

Claas, a German manufacturer of combine harvesters and tractors, last week announced it would
acquire a majority stake in Jinyee, a Chinese maker of farm machinery, writes Chris Bryant.

Given the gloomier outlook for China, this might seem an odd moment for such a move but Theo
Freye, head of Claas’s management board, has no regrets. “We see that agriculture and
agricultural machinery in China remain on a stable growth trajectory, independent from the
overall economic development,” he says.

In past years, German companies profited handsomely from China’s demand for high-tech
machinery and exported €67bn worth of goods there last year. About 1m German jobs are
estimated to depend on exports to the Asian power. Now German exporters are beginning to feel
the effects of a slowdown and this trend is expected to be highlighted when they report second-
quarter figures.

Siegfried Russwurm, head of Siemens’ industry unit, said in April: “China is not and probably
will not be an area of strength for the next quarters . . . But we are convinced that in the long run
China is the place to be.”

Between the first quarter of 2012 and the same period this year, German shipments to China fell
7 per cent. That loss is equivalent to 0.5 per cent of German gross domestic product, says Gilles
Moec of Deutsche Bank.

However, the German engineering association VDMA still expects single-digit growth rates in
machinery exports to China. This confidence is reflected in a recent survey of 500 German
businesses in China, 47 per cent of which said they expected business in the country to improve
over 2013, with a further 38 per cent confident the market would remain unchanged. Only 14 per
cent predicted worse conditions.

...
 ©Bloomberg

Luxury

When the head of Galeries Lafayette, France’s best-known department store, met officials in
China this year, he realised something was amiss, writes Scheherazade Daneshku.

“No one around the table was wearing a watch,” says Philippe Houzé, chief executive of the
group.

The effect of the Chinese government’s ban on television advertisements touting expensive
watches and other luxury items as “gifts for leaders” had made itself felt and, with the economic
slowdown, has dealt a double blow to luxury goods.

With Europe in stagnation, luxury goods companies came to rely on China, the world’s largest
luxury market after the US, with sales of €23bn last year.

So the effect of the double whammy has been marked – exports of Swiss watches to mainland
China fell 25 per cent in the four months to the end of April, compared with the same period last
year. Sales of handbags, such as Louis Vuitton, have slowed sharply as has demand for cognac –
such as Rémy Cointreau’s Louis XIII, which retails from about $2,500 a bottle.

The slowdown has not hit all luxury categories uniformly. And there are signs of recovery.
Britain’s Burberry has reported double-digit sales growth in China in the three months to the end
of June. Altagamma, the Italian luxury goods association, and consultants Bain estimate that
luxury sales in China rose 20 per cent last year but forecast a slowdown to 6-8 per cent this year.

That is still higher than their 4-5 per cent global growth forecast, and for most luxury goods
companies, that is the point: China has vital potential for producing large numbers of aspirational
consumers. Although they may be created at a slower rate than in the recent past, that rate will
still be faster than in many other parts of the world.