China's Other Achilles' Heel

Posted in the China Real Time Report, Wall Street Journal

May 5, 2010

In my entry last week I talked about China's property policies and whether they would "tank" GDP growth rates. I answered in the negative. The other China GDP risk factor, beside property-investment growth, is net exports. In light of the Greek crisis and possible contagion, here are my thoughts on the net-export side of China's growth.

China's net exports were about $300 billion in 2008 and $200 billion in 2009. In 2007 net-export growth contributed 2.6 of nearly 13 percent GDP growth; in 2008, 0.8 of 9 percent; and in 2009, negative 3.9 of 8.7 percent growth. The 2010 GDP outlook for China-with median expectations of 9.9 percent growth, and a high/low of 11 percent/9 percent-is predicated on net exports coming out flat: near-zero growth or only a slight decline. After a modest net-export performance in the first quarter of 2010, China's Ministry of Commerce (MOFCOM) extrapolated that net exports would fall to $100 billion this year-which would be a big drag on real GDP growth. For such a scenario to eventuate, MOFCOM must be presuming that the United States and Europe double dip and experience flailing growth the rest of this year; otherwise, something like flat net-export performance is far more likely for China.

The seriousness of China's property pullback is sinking in. This is expected to reduce China's imports and hence push up net exports. However, I don't think there will be an across the board real estate dip, as non-high end real estate will be promoted at the same time as high-end property cools off-this was my point last week. But what about a double dip in Europe, arising from the Greek debacle? Is MOFCOM's gloomy extrapolation likely after all? Figure 1 below reminds us that Europe has surged over less than a decade to compete neck and neck for the title of China's biggest surplus trade region, and thus a major EU import pullback would be painful for China.

Figure 1

Figure 2 below shows the evolution of China's monthly exports to the European markets most at risk of crisis and contagion: Greece, Italy, Spain, Portugal, Ireland (the PIIGS), Poland, and Latvia. On the right-hand axis is the sum of these exports as a share of all Chinese exports. Certainly this grouping has been growing as a destination for China's exports and $5 billion a month for the bunch is not too shabby. But consider the dark gray line: this risky group of PIIGS and friends is only 4 to 5 percent of China's total world exports. Europe is 22 percent or so, so this set is less than one-fifth of Europe.

Figure 2

The modest decline in China's imports, arising from property correction and hence natural resource import volumes and values, and the modest decline in EU-bound manufactured goods exports arising from Greece would likely offset one another. From where we stand today, I see no reason to mark down full-year China GDP expectations below the 9 to 10 percent consensus range due to the troubles in Europe's PIIGS. Greece alone is trivial; for this whole discussion to even be worth having, one must consider the spillover scenario, but even that is not reason to panic over China's exports.

Instead, I think the most important indicator of macro China problems that would get us below that growth outlook remains the other pigs-the ones that oink and that still portend considerable consumer price index inflation just over the horizon-which could compel further cooling off policies from Beijing, including interest rate hikes that would slow GDP and impair corporate and household mortgage debt repayment.