This cycle of restructuring will be the fatal blow for capital intensive companies.
A few days ago, Deputy Commissioner of the National Bureau of Statistics of China Xu Xianchun said “The Chinese economy may have already entered a period of restructuring. In the next few years, the speed of our country’s economic growth will gradually start to slow down.” Many organisations believe that 2007 was most likely the peak of economic growth in the current cycle. This year, economic growth might reach a ‘turning point’. However, if we carefully analyse the origins of this period of prosperity for China in the current economic cycle, this type of view does not seem to stand up
The ‘turning point’ view does not stand up to scrutiny.
Many organisations believe that a key reason why the Chinese economy seemed to reach a peak in 2007 was due to the “In 2008 the Chinese economy must be prevented from overheating and from the onset of inflation” decision of the Central Economic Working Conference at the end of the year. Another key factor was the accompanying macro-economic regulatory policies. These include tight monetary policy, industry restrictions and price controls.
It should be said that these measures aimed at squeezing the economy are quite powerful, especially the monetary squeezes. Since the increase in ‘zero credit’ starting in the fourth quarter of 2007, the stock market and the housing market immediately started to undergo significant readjustment. At the same time, in the broader economy businesses universally felt under great financial pressure. Up till now the strict credit control policy has caused the stock market to plunge, and has left SMEs1 desperately searching for funding . In May this year the CPI2 showed signs of easing off for the first time.
However, tight monetary policy measures will only have a temporary effect. This is because the period of economic prosperity since 2004, was due to credit inflation as a result of the government’s linked exchange rate policy which undervalued the renminbi. So the [main source of] demand-pull inflationary pressure comes from abroad and not from the domestic financial system itself. The flood of US dollars into China has created and maintained huge foreign currency reseves. This is the source of the current excess in the domestic money supply.
When the monetary squeezes cause a reduction in domestic asset prices, the US Federal Reserve will [greatly] lower interest rates. Currently, the renminbi is already greatly undervalued so this will cause the gap between the value of the dollar and the RMB to widen once again. However, in the latter half of 2008 the ‘oil drought’, ‘electricity drought’ and a dramatic rise in the PPI index3 all show that aggregate social demand4 is still not under control. This is due to a surge in flows of hot money5 into China and the wave of infrastructure and capital construction started by the government in March. Therefore the emerging turnaround in the economy this year, will perhaps only a minor one.
If the economy is to reach a turning point the value of the RMB must rise significantly. Only when China has its own, independent exchange rate policy can it have independent monetary policy. This time, the People's Bank of China can raise interest rates, making the real savings rate turn positive. The People’s Bank should also switch from using [monetary policy for] quantity controls, and move towards price controls6. Only then can we see a significant restructuring in the economy.
The top Chinese companies have taken the biggest hits
The regulatory policies put in place in the fourth quarter of 2007 caused the economy to adjust temporarily. This has given businesses early indications of future economic trends since the primary means of economic regulation is raising interest rates. This will be the fatal blow for capital-intensive industries such as property firms, especially those property firms with an excessive debt to net worth ratio. Bankruptcy will be almost inevitable. In this round of major economic restructuring the businesses having a tough time are those which expanded too quickly, with tight working capital7. When interest rates are raised, these businesses will be deprived of their cheap source of funding, and almost all of them will close down in no time at all.
Despite all this, economic restructuring is not the end of the world. The resources for the economic system [with the restructuring of different sectors of the economy], originally came from the cheaply funded, but prosperous, property and industry sectors. These include leading businesses without which the economy would grind to a halt8 such as the energy firms, mining and excavation and property firms. However, smaller production firms such as those producing everyday consumer goods, domestic appliances, food and medical products, were not necessarily in difficulty, since consumer demand has superceded investment and exports are the driving force of the economy, hence these were the first firms to benefit. Businesses in these areas can even take advantage of these difficult times to carry out industry reshuffling, finally coming to the fore and achieving great success. The so-called ‘crisis’ is a threat to China’s top businesses, but for smaller firms dealing in consumer goods, it is actually a great opportunity. (Author/ Xu Bin)
Notes: 1 SMEs: Small and medium sized enterprises
2 CPI: Consumer Price Index, a measure of inflation
3 PPI: Producer Price Index
4 Aggregate social demand: Aggregate demand less government spending i.e. consumption+investment+exports
5 Hot money: A inflow of funds in order take advantage of relatively high interest rates
6 To switch from controlling the money supply to the price of money.
7 Literally: Firms with a creaking capital chain, i.e. facing huge pressure or strain on working capital
8 国民经济引擎灯将熄火Literally: The engine of the economy would stop working