The factory and the market reversed

CHINA KNOWLEDGE

The factory and the market reversed

The world's largest economy and its fastest-growing one are swapping roles, threatening to jumpstart a vicious cycle

TIGER TONG

On July 31, China's State Administration of Taxation announced that it would raise tax rebates on a range of garment and textile exports to 13% from 11%, with immediate effect from the next day. The increase, the first for the industry in five years, signals that China's export business is now in the doldrums.

In the first half of 2008, export growth of garments and textiles has stagnated, with the garment industry affected the most. Total exports of garments were $49.96 billion, rising by 3.4% year-on-year, much lower than China's overall export growth rate of 21.9% for the period. In Guangdong province, the largest exporter in the country, garment exports decreased by 31.3%.

Shrinking profit margins and weakening overseas demand have pushed more exporters to the brink of bankruptcy, and most of them are small and medium-sized enterprises (SMEs). Currently, among 44,200 registered textile manufacturers, only one-third are still making profits, according to the China National Textile and Apparel Council. More than half of the SMEs are struggling to break even, and the average profit margin of about two-thirds of them has been squeezed to 0.67%.

Although the higher tax rebate may give a break to ailing exporters and help ease the concern over a jump in unemployment, it is not a cure-all as the two major causes _ increasing domestic costs and decreasing overseas demand _ still exist.

In fact, these two are the common problems faced by all Chinese exporters.

In the first half of 2008, China's total exports amounted to $666.6 billion, up 21.9% year-on-year, which was 5.7 percentage points lower than in the same period of 2007. However, the real growth rate will be much lower if we convert the value into renminbi, considering the local currency has appreciated by 9% year-on-year during the period.

In recent years, except for the month of the Lunar New Year, China's export growth has always been higher than 20%, but in June, a traditional peak season, the growth rate fell to 17.6%.

One of the major factors behind the decline is the Beijing government's adjustment in export tax rebate last July. In a bid to curb the growth of the country's ballooning foreign trade surplus, the Ministry of Finance reduced and cancelled tax rebates for 2,831 goods, accounting for 37% of all exported goods.

The trade surplus has since narrowed. However, beyond the expectations of Chinese decision-makers, the deepening of the US economic slump, along with other negative factors, such as accelerated RMB appreciation, raw material price and labour cost increases, and credit shrinking, all occurred at the same time and started to affect the economy.

Quite a number of Chinese enterprises, especially SMEs, are really in trouble. In the first half, about 67,000 SMEs claimed bankruptcy, including more than 10,000 labour-intensive textile companies. China is paying the price for its export-oriented industrial structure, which relies heavily on labour-intensive and resource-consuming industries.

Although China could subsidise domestic exporters for their rising costs, it is hard to change the situation of a weakening demand globally. After the deceleration of exports in the first half, the question that matters most now is how China's exports will grow in the second half. The outlook seems not to be so optimistic as growth is still largely linked to the economic situation in the US, China's largest trading partner.

Few positive figures have been released on the US economy in recent months. The US Commerce Department indicated that GDP grew at a modest 1.9% pace in the second quarter, after a huge emergency fiscal stimulus. Although one percentage point higher than the weak 0.9% posted in the first quarter, the growth is far below the market expectation of 2.4%. Further, the revised economic data show the economy contracted 0.2% in the last quarter of 2007, the weakest quarterly result since the 2001-02 recessions.

Even though real GDP bounced back from negative growth, the US economy remains very fragile. In fact, it would have contracted by 0.5% without considering the surging exports and shrinking imports, which largely resulted from the slumping US dollar.

In the second quarter, US exports increased by 9.2%, even faster than the 5.1% rate in the first quarter. Meanwhile, imports dropped by 6.6%, compared with a 0.8% fall in the first quarter. This narrowed the trade deficit to an annual pace of $395.2 billion in the second quarter, the lowest level in seven years. The increase in exports added 2.42 percentage points to GDP growth.

Meanwhile, personal consumption, which accounts for about 70% of the total GDP in the US, only contributed 1.08 points to the economic growth rate in the second quarter. Consumer spending rose 0.6% in June at annual rate, down from 0.8% in May, representing the weakest rise in incomes since April 2007. The figures indicate that the government's $160 billion in tax rebates only temporarily boosted consumers' confidence.

It is likely that China's largest trading partner is now facing the problem of recession coupled with inflation worries. At present, the country's positive growth relies on a shrinking trade deficit. In China, however, for the first half of 2008, among the largest three driven forces, only the growth of consumption was higher than last year, while the export and investment has been stagnated.

An ironic situation is easily seen here. China, the world's largest factory, is now heading to become the world largest market, while its counterpart, the US, is turning from the world's largest market to the world's largest factory.

However, the situation will not be sustainable for long as weakening demand from the US will eventually diminish China's export business, which will, in turn, reduce the demand for US-made products.

In the long run, a vicious cycle will start between the US and the emerging market, and China will see ill omens for its economic growth ahead.

The contributor is the Research Director and Managing Consultant with China Knowledge Consulting. The firm provides corporate services, financial advisory, marketing strategy and recruitment to foreign businesses seeking business opportunities in China. Opinions expressed are her own.