The Chinese Economy and The rest of the World

With the global economic situation getting more complex and tense as time goes by, the focus of financial authorities – Namely the Federal Reserve and European central Bank - is China. In many ways they monitor close developments in China in search of signs of improvements.  China these days is almost synonymous to growth, stimulus and hope. All eyes turn to China when the topic of discussion is Global Economic Recovery.

Unfortunately, for both – ECB & Federal Reserve-  and leading policy makers elsewhere, the situation in China is not improving. On the contrary, if one takes a deeper look into the Chinese figures released, there are more reasons for concern than relief.

The People’s Bank of China (PBOC) is trying to do damage control by cutting official short term rates. They are cutting aggressively, but the problem is that INFLATION is falling faster than rate cuts, which means that in essence the real Deposit Rate is Not falling But Raising.

During the month of June, Chinese consumer Price index Deflated and declined for the 3^rd time in the last 4. The pace of the decline is accelerating; CPI has dropped from 0.3% in May to 0.6% in June, a sharp decline indeed. 

Consumer Price Index figures:

Contraction: June +2.2%  from May +3.0%. 80 basis points decrease on a monthly basis and the result represents a drop of - 430 basis points from the July 2011 CPI of +6.5%

The central Bank has cut rates by 50 basis points this year, but CPI has dropped 230 basis point since January – the same period – and that is not all. The 430 basis points drop in CPI July leaves nor room for discussion. The CPI inflation during June was 80 Basis points; So June alone surpasses the Interest rate cuts.

The contraction is broad based. It is affecting every single sector of the Chinese Economy.

CPI Consumer Goods:  June +2.3% down 130 basis points from May 3.6%:

CPI Food: +3.8% down 260 basis points from May +6.4%;

CPI Household Items: +1.9% therefore unchanged from May +1.9%;

CPI Transportation-communication: -0.4% deeper into negative territory from May 0.1%

The PPI inflation registered a drop of -2.1% in June down from -1.4% in May and deepening into negative since the last positive result in January ( +0.7%). The real concern here is the size fo the contraction since July 2011: 940 Basis Points! July 2011 result was +7.5%. In August

The macroeconomic dynamic is deteriorating. The balance of trade in China is showing surpluses due to the rapid decline in Import figures. The trade surplus in June was US$31.1 Billion one of the largest in the history of china. This simply means that the contraction on exports has been massive since January. The recent result is one the largest in Chinese history; Actually, it is the largest one into “NORMAL” economic conditions and only inferior to other historical results when compared to the figures from the period October 2008 to January 2009. Imports have declined by US$ 13.6 Billion in June.

The year-year rate-of-change in Chinese Imports fell to +6.3% in June, registering a substantial contraction from May when it reached +12.7% yr-yr. The result fell far below this year's seasonal high registered in February: +39.6%

Industrial Production in China increased 9.5 percent in June of 2012. Historically, from 1990 until 2012, China Industrial Production averaged 13.4200 Percent reaching an all time high of 29.4000 Percent in August of 1994 and a record low of -21.1000 Percent in January of 1990. Industrial production measures changes in output for the industrial sector of the economy which includes manufacturing, mining, and utilities. Industrial Production is an important indicator for economic forecasting and is often used to measure inflation pressures as high levels of industrial production can lead to sudden changes in prices

One particular figure is Very significant in regards to the current state of affairs in China: The Crude Oil import figures. China's crude imports in June sagged to 5.29 million bpd, the lowest daily rate this year and 12 percent lower than the record 6.0 million bpd in May, reinforcing concerns about slowing demand for oil.The monthly decline in the volume of Chinese Imports of Crude Oil dropped by 3.76 million tons.

The decline in commodity imports was broad, as noted below (monthly changes):

 Steel Imports: down (-) 16.7% 

 Copper Imports: down (-) 17.5% 

 Copper Scrap Imports: . down (-) 11.9% 

 Iron Ore Imports: down (-) 8.7% 

 Refined Oil Product Imports: down (-) 15.6%

The only exceptions in the Commodity sector are grains:Soybean was the real exception. Demand for Soybean and Soy Meal has expanded dramatically.

The demand for Corn also remained solid, in spite of an overall drop, in percentage terms.   The demand for commodities still exist, however, the pace has slowed quite significantly.

To put it mildly, this shift should make entrepreneurs in Brazil concerned and serve as warning for possible changes in the near future. If the contraction in Chinese demand won’t be considered a reason for concern, I don’t really know what will!  

It is not a secret that we rely heavily on China as customer. The largest two economies in the world today are Europe (Eurozone) and China.  China is by far “Our Best Customer”;and now it has some serious problems.Therefore, we have problems.

Surprisingly, Brazilian Government officials and Entrepreneurs alike seemed confident that situation would be only temporary until recently. when asked about the current situation, It is a bit surprising, given the role China plays in the world economy. Either they know something we don't or they have found a very good replacement ready to step up and replace China as customer when the Chinese are not performing as expected. 

 I just wonder who that replacement might be and from which PLANET it is coming from? As far as I am concerned, in the planet we live, there isn’t a single CLIENT with the power and stature of China. The only potential replacement for China at this stage would be India; But India has to travel a long way before reaching the level of China .

Moving to the Financial markets, the 5 year swap rates have dropped dramatically.

Rates in june were 2.57 down from 3.50 in March. The rates dropped below the previous low of December 2011. The 5 year rate has dropped below the 1 year Deposit Rate. 

However, with all being considered, the rate has dropped slower than CPI. Therefore, the Shanghai overnight borrowing rate has INCREASED.  Along with the drop in rates, so does the Strength of the Chinese Currency against the US dollar. For the first time, the Chinese currency is really experiencing pressure – real pressure – from the open market and not from PBOC intervention.

The pressure is also spreading towards the Equities index in China. Chinese stocks have under-performed the SP500 and several European Indexes. It is a fact that most of so called Emerging markets have had terrible performance this year. Chinese stocks are performing poorly; how they will perform on the near future leaves room to large speculation. The exceptions amongst the emerging markets have been Thailand, Philippines, Indonesia and Singaporean markets. All relatively small exchanges, also called a satellite or peripheral markets.

This pressure means that performance from Chinese companies have been below expectations and means that for the time being, we should not expect any significant recoveries on the short term. Many would argue that the current low levels are so attractive that investors would be losing another Rare or ONCE IN A LIFETIME opportunity to invest in Emerging Countries/ stocks. There are certainly very interesting companies providing good opportunities at current levels. However, one must look into it, case by case, and not simply buy because it is relatively cheap! What is cheap or a bargain in financial markets becomes very relative.

Stock markets, such as any other speculative markets are DYNAMIC. They change constantly. Valuations should be made in relation to other possible opportunities within (not Only)Equities Markets, but also other asset classes. That is true for Chinese, Brazilian, European or American Stocks.

The PBOC is moving slowly and acting according to its own agenda and sentiment. It is taking actions at a pace that satisfies their own views of what is acceptable and what is not. The fact that other nations are RELYING on China for their own recovery IS NOT a priority to the Chinese. Their main concern is China.

Certainly, pressure is being exerted by International leaders (heads of states) principally with  elections approaching in the USA and Germany, in efforts to see the Chinese DO SOMETHING and try to change the current climate of uncertainty. In my opinion, they are wasting their time. As much as they try, we can rest assured that what concerns the Chinese, these are empty attempts and will do little to influence decision makers.

How this will play out for Brazilian Companies?

If all stays the same, Brazilian companies relying heavily upon China will face some difficult times in the short term future. China will not stop to acquire raw materials; however, they will change the pace and operate at slower fashion. 

They will be more cautious in terms of future commitments. There is little doubt that the Chinese will continue to acquire large quantities of commodities and raw materials they are not able to produce. They will hold the the position of Key Customers for commodity exporting nations for the foreseeable future. However, how much, how, who and when, is now a matter of speculation.  They will build alliances - strategic alliances - that will serve mutual interests.

Will they meet the targets and expectations set by corporations worldwide in terms of volumes of sales? Nobody knows. Real figures could differ wildly from the projections, leading to disappointing results for companies relying on Chinese counterparts as key revenue driver.