China is no longer just a question for Asia fund managers: what happens to China can have a substantial impact on global markets.One way that China’s importance manifests itself is in relation to the most popular sectors in world markets. As Merrill’s chief global investment strategist David Bowers notes, these are sectors such as energy, which have benefited from Chinese demand. “It’s almost China coming to the rescue of tactical cyclical positions,” he says. More generally, he says, the character of Chinese growth is a key debate in global markets. Fund managers are trying to work out whether China is part of the US supply chain or whether its growth is self-sustaining. To understand why this matters, it is necessary to take a step back; in particular, it is important to recognise that the US and China are the two key drivers of the world economy at present. There are several reasons why they are so central. The most obvious is that measured on a purchasing power parity basis (taking into account different price levels in different countries), they are the world’s two largest economies. The US accounts for 21.1% of global output, according to the
International Monetary Fund, while China represents 12.6%. In contrast, Britain is only 3.2% of the world economy. But there are other reasons besides size that make China important. One is that it is such an open economy: China’s trade and investment patterns are highly integrated with the rest of the world. So, for example, it is hugely dependent on the world as a source of raw materials and high technology goods. It is also, as a visit to Dixons or a toy shop will illustrate, a massive supplier of many types of goods to the rest of the world. China is disproportionately important as a contributor to global economic growth. Although its economy is just over half the size of America’s, it is forecast to grow by 9.0% this year by the IMF. In contrast, the US is expected to grow at only 4.3%. Therefore, China is a bigger contributor to global economic growth than the US. China’s importance has gained increasing recognition over the past year. The debate over whether an apparently overheating Chinese economy is heading for a hard or soft landing has attracted
substantial attention. An interesting feature of the Merrill Lynch survey is that such concerns seem to have diminished. Back in July a net 39% of global fund managers said they expected the Chinese economy to become weaker over the subsequent 12 months. By October, the figure had fallen to only 6%. Similarly, Merrill’s regional poll of Pacific ex Japan fund managers showed concern about China peaking from May to July. It has fallen sharply since. A subtle shift seems to be under way in perceptions of how problems in China could affect the world economy. A few months ago the emphasis was on the danger of China’s overheating economy suddenly slowing down. Rapid investment growth within China was widely seen as a symptom of a bubble that was about to burst. Today the emphasis is more on the dangers of a co-ordinated slowdown in the US and China. Since the two of them account for over a third of global output, their fortunes inevitably have a large effect on the rest of the world. In addition, a slowdown in the US could increase the chances of a Chinese “hard landing” – a fall to a much slower growth rate. For Diana Choyleva, a senior economist at consultancy Lombard Street Research, the extent of the US slowdown is “a key issue in
forecasting a [Chinese] hard landing next year”. She says: “If external demand worsens, China will have to rely on domestic demand to sustain growth.” However, consumers are unlikely to have the resources to pick up the slack if external demand does slow. Angus Tulloch, head of global emerging markets at First State Investments, emphasises that the impact of a US slowdown on China depends largely on its extent: “China would be only marginally affected if there was a minor slowdown in the US. However, if a major slowdown occurred,
specifically if the US went into negative growth mode, China would be impacted because of exports to the US. “If there was a sharp reduction in US consumption expenditure, this could have a much more significant impact on China’s economic prospects, as growth in its domestic consumption and intra-regional trade might not be enough to compensate.” The Merrill Lynch survey shows that fund managers are becoming more pessimistic about global economic prospects. A net 25% said in October that they expected the global economy to slow in the coming year, compared with 14% in September. Earlier this month, the IMF revised its projections of US GDP growth down by 0.3 percentage points for both 2004 and 2005 (see Fund Strategy, October 4, page 12). They now stand at 4.3% for this year and 3.5% for next. However, it should be said that the IMF was optimistic about global growth overall, with a forecast 5.0% rise in output growth for 2004. One particular concern is that if Chinese economic growth slows, it could quell the nation’s growing appetite for foreign goods. Raw material prices in particular could suffer as a result of dampening Chinese demand. Some argue that slowing Chinese demand was to blame for the decline in the base metals markets on October 13. The prices of metals such as copper, lead, nickel, tin and zinc fell sharply on the day. Other analysts countered that the fall was from a high base and happened under thin trading conditions. Whatever was to blame for the sharp fall in mid-October, there is little doubt that a fall in Chinese demand would hit commodity prices. China is responsible for the bulk of the growing global demand for natural resources. Although such a correction would benefit some – as it would help quell inflationary pressures – it would be bad news for raw material producers. It is no longer sufficient for investment managers and fund
strategists to keep a close eye on Wall Street. Developments in China, including the mainland as well as Hong Kong and Taiwan, are having an increasingly important effect on global markets. Even though the Chinese equity market is relatively underdeveloped, the country’s surging economy has an impact on companies all over the world.