This Chinese industry can spell trouble for the global economy!

Jun 1, 2011

In this issue:
» India's GDP growth slowest in 5 quarters
» Will the sun shine on Indian SMEs?
» Should companies acquire land directly from owners?
» UK consumer recovery to be slowest in 180 years
» ...and more!
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This may sound counter-intuitive to most Indians, but there was a time in China when most people there didn't think they would ever own a home. Then something changed radically in 1998. The Communist government decided to privatise most of its urban residential housing stock. Rest all is now history. The Chinese real estate and construction industry has grown at a very furious pace over the last decade.

The country has now launched a massive drive to keep the boom in the construction industry going and to also address issues of growing income disparities. The Chinese government has ambitious plans to build about 36 m subsidised housing units in the next 5 years. Meaning, people who cannot afford to buy or rent houses in cities will be offered the same at significant discounts.

But why is the world so worried about the Chinese property market? Let us explain a bit and you will agree that it is definitely a matter of concern.

The growth model of Mainland China is heavily dependent on the real estate and housing construction sector. This sector, in turn, is a crucial determinant of commodity demand. If certain estimates are to be believed, the Chinese dragon devours up to 50% of important global commodities and materials like steel, iron ore, coal and cement. For instance, about 40% of China's steel demand comes from direct construction activity. But if you account for property-related and property-dependent steel demand, it would account for more than 65% of China's total steel consumption.

So it's clear how important a player China is in the global commodity and materials market. It is no wonder then that any slowdown in the Chinese property market will have major global repercussions. If you look at the economic data of recent months, it is evident that manufacturing activity has slowed down on the back of monetary tightening. Though it is difficult to predict the fate of the Chinese property market, whenever the tide turns, the tremors will rock the entire globe.

Do you think any trouble in the Chinese property market will have major global implications? Share your comments with us or post your views on facebook page.

 Chart of the day
The last couple of years saw emerging economies in Asia reporting stupendous growth in Gross Domestic Product (GDP) which in turn fuelled stock market indices in those regions as well. But this growth momentum has begun to get cold feet. And the factors that have led to this slowdown are none other than high inflation and the consequent rise in interest rates. Rising inflation in India had led nervous policymakers to raise interest rates nine times in a row. Quite obviously, high interest rates slowed down investments and in turn, affected growth. Today's chart of the day shows that India's GDP for the January-March 2011 quarter has registered the slowest (year-on-year) growth in the last 5 quarters. It reported 7.8% YoY growth in GDP during the quarter against 8.6% YoY growth in the corresponding quarter last year.

Indeed, it is not just India but several countries in this fastest growing region that are facing the brunt of inflation. One is forced to wonder whether this slowdown is a short term phenomenon or whether we are beginning to witness a more prolonged slump. Other than inflation, oversupply has also been another reason which has led to slowdown in profits of various Asian companies who have responded by cutting back production. To add even further, a meaningful recovery has not really taken place in the developed economies of Europe and the US. Most probably, emerging economies in Asia will be on the back foot until such time that inflation is brought under control. But from a long term perspective, strong demand and immense growth potential should still see these economies outperforming those in the West.

(GDP growth rate at 2004-05 prices)
Data source: Central Statistical Organisation

When it comes to financing, it is argued that the large firms usually have the world at their feet. Investment bankers form a beeline at their headquarters and banks seemingly go out of their way to offer funds at pretty favourable terms. The small and medium sized firms (SMEs) on the other hand are not that lucky. They are usually the ones who end up getting the rough end of the stick. Even though the irony is that their contribution perhaps is more important to the development of a grassroots economy than their larger counterparts. In view of this, any effort being made to improve access to cheap financing for SMEs has to be certainly lauded. And this is exactly what we felt like doing when we heard that SEBI- India's market regulator-has given its provisional approval to set up separate platforms for SMEs on stock exchanges.

The idea is no doubt a sound one. After all, even SMEs have the right to raise money through IPOs and, hence, get access to long term money for growing their businesses. But we would be making a big mistake if we underestimate the risks involved. It should be noted that chances of an SME business model going awry and failing is much higher than that of a large cap company. Then there is also the issue of sound corporate governance policies, which as we all know is compromised at a higher frequency in SMEs than large companies. There is no doubt that a dedicated platform for SMEs will give investors access to a much larger pool of companies. Their due diligence, however, will also have to go up a great deal. Failing the same, there would be more money to lose than gain we believe.

Acquiring land for building infrastructure or new industrial capacities has become the biggest challenge to India's growth. Lack of political and economic consensus on most large land acquisition proposals has pushed back critical projects by several years. But the latest development about a proposal on simplifying land acquisition rules could seal the prospects all together. The National Advisory Council believes that private companies should be disallowed from buying land directly from owners, particularly where more than 400 families need to be displaced. FICCI, on the other hand believes that adequate compensation is the only way the land problems can be resolved. Also, disallowing private initiative in land acquisition could unnecessarily burden the state government with the problem. Hence, it believes adopting the Haryana model of compensating landowners through long term annuities could pay off. We would certainly want to be on FICCI's side. But whatever be the decision, a quick consensus amongst the policy makers with a practical approach will surely serve the interests of the economy.

The Indian telecom industry has been in doldrums in recent times. Hyper-competition has been a main reason for this. With nearly 12 to 13 operators in each circle competing for subscribers, rates have plummeted to new lows. As a result, operators have found it increasingly difficult to continue operations in a profitable way. The telecom operators blame the government for this state. According to them, the government has strict and stringent regulations that are not conducive to industry growth.

The current rules on issues like mergers and acquisitions actually deter consolidation instead of supporting it. Additional issues like spectrum charges, spectrum sharing, etc that can actually help in easing the pressure on margins are just not dealt with in the current telecom policy. As a result, most operators have cut back any additional investments into the networks. This, in turn, is hampering network quality and raising questions on future growth. To address all this, the telecom minister has promised that he would deal with all these issues in the new policy which is expected to be in place by September this year. The new telecom policy would resolve the issues in a manner that is both conducive to industry's growth without hampering the interests of the consumers or the government. However, given the government's track record in dealing with such issues, we would keep our hopes restrained.

While the UK economy struggles to recover, consumer spending has dwindled significantly. In fact, UK is witnessing the slowest recovery in consumer spending in 180 years. Recent trends suggest that consumer spending in 2015 will be just 5.4% above the 2008 peak. This slow growth may be attributed to high inflation, rising taxes and slow growth in wages. However, the average recovery of 12% above the previous peak has been observed in the past.

In the meanwhile, the Indian stock markets have been trading strong. At the time of writing, the benchmark BSE-Sensex was up by 42 points (0.2%). Capital goods and PSU stocks were boosting the markets while Consumer durables and Realty were trading weak. Barring Hong Kong, Malaysia and South Korea, Asian stock markets too were trading in the green. European stock markets have opened on a mixed note.

 Today's investing mantra
"You only have to do a very few things right in your life so long as you don't do too many things wrong." - Warren Buffet

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8 Responses to "This Chinese industry can spell trouble for the global economy!"


Dec 17, 2012

No, this is not completely true. In 1998, Chinese did'nt own a home because they had state provided housing for lifetime (yes, not only for government employees, but all employees). Unemployed had no way to enter the city without a work permit. And a commodity slump will not happen soon. China has the money to build 36m houses and will do so. They understand the nature of capitalism and much more effectively influence global trade than Indians.


Nagaraj BG

Jun 2, 2011

No, I do not think China would affect the world to that extent as other countries in Africa and Asia will pick those commodities as and when the price starts falling.. High prices of these metals/commodities (like steel) may have stunted the growth elsewhere and they start picking up from now onwards. Be cool!


Jatinkumar Ashara

Jun 1, 2011

Hey, I m not grt at this but do u mean that if China starts consuming more of its commodities like steel, iron ore, cement for such subsidised housing and thereby it will export less and that shall affect the prices across the globe..reply


Subhraveti N Rama Gopal

Jun 1, 2011

In a global situation of "dog-eat-dog" adopted the so called mighty markets of US, Europe etc, which Govt is bothered by the effects of its policies on other countries? I appreciate the proposal of Chinese Govt initiative to provide basic amenity of housing at affordable cost to its citizens. Its a step taken by a benevolent Govt and it helps 36 million families. It does not matter if US or UK or other developed markets suffer due to a move that helps such a large chunk of humans, be they in China or else where. If India is self sufficient in these materials, it can ban the exports and make similar efforts that will bring dividends to its populace in long run. Else it should try for making itself self reliant.



Jun 1, 2011

The secret Chinese dragon economy is going to trip and cause major damage to global economy. Their growth is too good to be true and has been unnatural for a while. They are building things and consuming just to keep the GDP in double digit and add to this the closed door approach and lack of transparency - the world doesn't know what is the real story. What is not natural is not sustainable and will have to fall in to law of nature, what goes up has to come down.



Jun 1, 2011

I'm sorry to say this but 5 minute wrap up and the Daily reckoning by Bill Bonner is almost always negative and highly pessimistic. Bill just cannot see light at the end of the tunnel i guess ever. Most of these things might not end up happening by the way and even if it happens, it doesn't spell Dooms day. This kind of pessimism is totally in contrast to your recommendations and that sounds contradictory. So, i reckon some correction is needed in the whole approach behind the article.



Jun 1, 2011

It is not a question of whether the property bubble will burst, it is only when. And yes, the consequences will be more catastrophic and contagious than we can imagine.



Jun 1, 2011

Chinese economy is primarily infrastructure and exports driven. With EU, US in trouble, they need to find alternative countries for exports. With rising inflation, housing can't maintain pace. Infrastructure can't go on growth path forever, particularly if the returns are not commensurate. Looks like, Banking industry in China is in for trouble, if they dont watch out for the creditworthiness of the borrowers. It may not have as much impact on global economy as in 2008, because of realistic interest rates and one-third the economic size of China compared to US.

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