China: The dragon slows down! - Views on News from Equitymaster

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China: The dragon slows down!

Mar 29, 2004

Wait! This is not a title apt for present times when the Chinese economy is witnessing an accelerated growth rate that would put many developed nations to shame. This is, in fact, a futuristic expression of what might happen once the Chinese administration, as it is thinking now, decides to pull brakes on the economy thus slowing down its growth rate. Read on this article that might capture the state of the Chinese economy and its effect on global (read Indian) growth as in 2010 AD. Forward to 2010...

"China, the world's second largest economy after the US, witnessed a GDP growth rate of 5% in 2010, lower than the average of 7.5% that it had witnessed over the past seven years (since 2003). While China has traditionally been the growth driver for the world economy, this slowdown might make things worse for the 'China-dependent' economies. This is mainly due to the fact that these economies have been dependent on the Chinese consumer (both industrial and retail), thus failing to put in a contingency plan in place (like propping up domestic demand). And they are now paying for their faults of the past.

Going back to the middle of 2004, when the Chinese administration pondered first whether it was time to slow the 'over-heating' economy, almost no one heeded to that warning. Companies, both in consumer and commodities segments, from the supplier countries continued to pile up capacities in order to benefit from the growing demand. Be it automobiles, steel and other consumer durables, everyone outlined their future prospects with those of the Chinese economy. And they were not disappointed to start out with. According to Morgan Stanley, 'In 2003, China accounted for almost 7% of the global consumption for crude, 30% of iron ore, a similar amount of coal, 25% each of steel and aluminium products and 2/5ths of cement production.' These indicators are enough to estimate the kind of dependence that had creeped in these countries on the Chinese consumer.

However, the Chinese administration decided to keep the economy from overheating. This had a significant impact on the global economy. Apart from leading a crash in commodity prices, the slowdown in demand in China resulted in excess capacities worldwide. Of course, the stock markets felt the impact, not only in China, but also in economies that were major exporters to China.

Added to this, the US Federal Reserve raised interest rates at the end of 2004. This led to a sudden outflow of Foreign Institutional Investors (FIIs) money that was invested in these growth economies. Those countries that had weak financial systems could not manage this sudden outflow of capital. However, there were some like India, which managed to hold up the contagion due to its inherent strengths (say, financial system).

Now in 2010, while the Chinese economy has slowed down considerably, what this means is that the dependent economies have to find out ways to put their 'oversized' capacities to use. Simply put, this means that these economies now have to prop up internal demand to escape the tribulations that this slowdown of the Chinese economy has created."

Back in 2004...

Well, that was just a brief of the events that might unfold in case the Chinese economy slows down considerably. This may happen in two ways -

  • One, owing to the decision of the Chinese administration, infrastructure spending is stepped down, and

  • Two, the economy continues to overheat and falls under its own weight (i.e., fails to sustain the high levels of growth).

If this were to happen, the commodity sectors will be the first to get a hit and perhaps, will suffer the most. Though we export some goods to China, in terms of GDP contribution it is not meaningful as of now. However, if the dependence increases, we will face a problem.

For India to sustain its growth in the long-term, initiatives like spending on infrastructure, tuning up institutions, checking corruption, and enhancing measures towards social security (housing, employment and education) have to be accelerated. And this would require initiatives not only from the government, but also from the private sector. If we are successful in doing so, this will create a larger internal demand for goods and services. And that will defend us not only from the slowdown in the Chinese economy, but also from the harms of the globalisation process.

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