China’s economy returns to the number two position

China’s effect on the South African economy cannot be under-estimated despite a slow-down in the growth of the world’s second largest economy, says Glenn Silverman, the Chief Investment Officer of Investment Solutions.

Silverman, who is outlining Investment Solutions’ overall and economic view on China at investor sessions in Cape Town and Johannesburg in the next week, is of the view that there is no other BRIC country that has nearly as much impact on South Africa, and Africa, than China.

Silverman was in China recently along with Investment Solutions’ Head of Market & Economic Research Lesiba Mothata. The trip is part of a two year program to visit one of the BRICS countries every six months, to better understand these key drivers of global economic growth, and the effect of each of them on investment markets, on each other, and on South Africa and Africa.

Silverman says China has done what virtually no other country in the globe has ever done before – grown at near double digits for some five decades. With a GDP of $8.2 trillion, China overtook Japan in 2010 as the second-largest economy in the world, with its effect felt in many areas, most specifically commodities.

“This return to the number two world ranking, only returns it to the position that it shared with the likes of India a millennium or two ago,” Silverman says, adding that it seems that China, along with India, are returning to their ‘rightful place’ on the global economic stage.

Whilst China’s double digit growth is now a thing of the past, at its current size, even were it to slow to an annual GDP growth rate of say 5%, that would still be equivalent to adding an economy the size of South Africa every year! Nevertheless, slower Chinese growth will likely have an amplified effect on sentiment, and hence on commodity prices, and shares.

Silverman identifies a number of fundamental issues that could affect China’s future economic growth. The first is simply the 'law of large numbers' which calls for an inevitable slowdown in an economy of its size. The Investment Solutions’ base-case view is that China is likely to experience a 1-2% slowdown every five odd years. A sharper slow-down would occur if one of three key identified risks were to occur -- shadow banking/over-indebtedness, a collapse in housing prices (especially in the Tier one cities), and further over-investment, as evidenced by falling returns on investments. These risks would then compound the already worsening demographic trends -- some 25% of Chinese are estimated to be over 60 years old by 2030, and an already contracting work-force. The final element in the 'bear' case would be the fact that the Chinese economy needs to transition from an export/manufacturing one, to one with a higher proportion of consumption. “This will likely take years if not decades, with the associated risks that pertains to any transition”, says Silverman.

“Although a major slow-down is not consensus, nor our 'base-case' view, there are some worrying signs, and the news flow will thus need to be monitored closely" says Silverman. This can be harder in China, where the data may not always be that reliable.

“There are, however, positives too, with evidence of a desire by the new leadership to embark on further reforms, a desire for more balanced and sustainable growth, huge financial muscle to do so (with some three and a half trillion dollars of reserve), growth opportunities still in the co-called tier two and three cities, and a less restrained, increasingly entrepreneurial and educated population” he says.

The Chinese economy is an interesting and complex one. At many levels it is fiercely competitive ('bottom-up') and ‘free market’ in its approach, whilst at the other extreme it is also very strictly controlled ('top-down’) by the Communist Party of China (the CPC, or more simply, ‘the party’). State Owned Enterprises (SOEs) are in/directly controlled by the party, but increasingly co-owned by private shareholders and competing directly on the global stage. China directs its economy by way of a detailed 'five year plan' which is disseminated and implemented first and foremost by these SOEs. These five year plans are ‘the be all and end all’ of economic policy. “This whole area of central government involvement in an economy is an important one to focus on as South Africa, and other countries, grapple with the optimal level of such involvement and control, in their respective economies,” says Silverman.

Silverman draws certain conclusion:

• China’s effect on South Africa and Africa is vast and important - few other countries come close.

• It is important that South Africa contrasts its NDP (The National Development Programme), with the likes of that in China. Whereas the CCP can and does dictate the five year plan, the structure of South Africa's economy & politics is very different, and thus makes buy-in, implementation and sheer focus, that much harder. The NDP will be critical to setting SA on a stronger growth path, notwithstanding the obvious challenges.

• Whilst there is a lot South Africa can learn from China, caution must be exercised too, so that the correct lessons are learnt. One needs to also recognise some quite stark differences - South Africa has a population of 50 million as opposed to China with some 1.3 billion i.e. we cannot simply follow a policy of 'build and they will come'. South Africa differs greatly too in terms of our respective history, culture, work ethic, economic and political systems etc. And whilst South Africa is a resource provider, China is a key user/buyer of resources. Priorities will and must thus differ.

“A new world order seems to be unfolding, with the BRICS at the centre of these changes. One will thus need to watch developments within the BRICS, and its largest member China most closely. Few other countries will count nearly as much,” said Silverman