Can the Shivering Dragon Shake Its Chills?

By Dr. Bernhard Hartmann,
Managing Director, Greater China Region, A.T. Kearney

The roaring dragon that has characterized China’s double-digit-growth-rate economy over the past five years is shivering today, as the chilling effects of an unprecedented economic winter continue to reverberate throughout the country and around the globe. Just a few months ago, it was believed that China was one of the least wounded of the leading economies affected by the global economic crisis and that it might even save the world from economic collapse. However, as the country’s export growth rate started to decline dramatically in the second half of 2008, it became clear that China’s economy was no longer the roaring dragon of the past five years, when double-digit growth reigned.

Indeed, exports are in negative territory for the first time in seven years, with a year-on-year growth rate of –2.2 percent in November 2008, dragging fourth quarter GDP growth down to 6.7 percent. In February 2009, exports continued to deteriorate, declining by roughly 17 percent, while a decline in industrial output led to rising unemployment, with almost 9 million people out of work by the end of 2008. This does not include the “informal workforce” of migrant workers, estimated to be around 20 million people, who do not have jobs due to the economic crisis.

China moved quickly to stem the tide. Thanks to a robust balance sheet and a relatively less-developed financial market, the central government was able to allocate resources to reboot the growth engine. In November 2008, the government announced its ambitious two-year, 4 trillion RMB (US$585 billion) stimulus package. Its extensive infrastructure development, social welfare plans and tax reforms presented a clear commitment to maintaining its 8 percent annual GDP growth rate.

Five months later, in March of this year, Chinese Premier Wen Jiabao confirmed that the 8 percent target was within reach, indicating there was no need for further economic stimulus packages. So far, several recent indicators hint that the economy is recovering. New lending in January was 1.62 trillion RMB, pointing to ramped up economic activity and the extension of credit to support the economy. In February, the purchasing manager index (PMI), measuring the health of the manufacturing sector, rebounded from 45.3 in January to 49. Although the PMI is below 50, denoting a still-weak manufacturing sector, continuous improvement in each component index predicts that a period of reexpansion in the production sector is approaching.

Since the Chinese government announced its eye-popping 4 trillion RMB stimulus package, conjecture on how the money will be spent has been non-stop. The recent National People’s Congress meeting in Beijing has to some extent uncovered the mystery. The stimulus package will focus on:

• Transportation and power grid infrastructure construction (1.5 trillion RMB)
• Post-earthquake reconstruction (1 trillion RMB)
• Social security housing (400 billion RMB)
• Rural infrastructure (370 billion RMB)
• Technology upgrade and industry structure (370 billion RMB)
• Environmental protection (210 billion RMB)
• Healthcare and education (150 billion RMB)

Compared to the preliminary plan introduced in 2008, investments in transportation and grid infrastructure and environmental protection have been curtailed in favor of focusing on social security housing, technology upgrades and healthcare, among others.

The government will provide financing support to small and mid-size firms in 10 key industries: automotive, iron and steel, textiles, equipment manufacturing, shipbuilding, electronics and information technology, petrochemicals, light industries, nonferrous metals, and logistics.

This adjustment shows China’s interest in improving areas directly linked to the “people’s livelihood” and transforming the economic growth engine. Rather than relying on exports, growth will be driven by booming domestic demand.

To spur domestic consumption quickly, and to start weaning its nation from exports, the Chinese government eliminated the 5 percent tax on vehicle purchases and launched a household appliances subsidy program (13 percent of the price) in rural areas.

Already benefiting from the subsidy program is China’s largest appliance maker, Haier. In the first stage, Haier’s market share of refrigerator sales reached almost 54 percent, allowing the company to surpass Whirlpool, LG and Electrolux to become the global sales leader of refrigerators. Now, a similar subsidy program for automobiles is underway.

Innovation and R&D take center stage. Improving innovation and R&D are part of an effort to set Chinese products apart from those produced elsewhere in the world. “Made in China,” often negatively equated with counterfeiting and infringement of intellectual property rights, generally has involved little, if any, innovation on the part of Chinese companies. In 2006, the Chinese government announced a 15- year plan to further develop the science and technology sector and to promote “indigenous innovation” by relying less on foreign technology and developing its own technological expertise.

In 2008, China filed for 6,089 patents, an increase of nearly 12 percent from the year before, signifying that the country is already well on its way to transforming “made in China” to “made by China.”

Overcapacity, one of the costs of becoming the “world’s factory,” is occurring in many industries, ranging from steel, cement and nonferrous metals to automobiles. As the global economy enters into an actual depression, consolidation in these industries will become unavoidable. Consider, as one example, China’s highly fragmented steel industry. The 2008 output of 560 million tons was produced in thousands of factories. Shanghai-based Baosteel, the largest steel enterprise in China, is no more than one-fourth the size of Mittal, the global leader. Baosteel and two other state-owned steelmakers are slated to serve as pilots in an effort to consolidate the industry. The goals include a 45 percent market concentration by the top five producers by 2011, with each pilot enterprise having a capacity in excess of 50 million tons.

How achievable is China’s goal of regaining its 8 percent GDP growth rate? The government’s confidence is based on its stimulus package and the resilient nature of the economy. But China’s State Information Council (SIC) is not so sanguine: Its forecast of a first quarter 2009 growth rate of 6.5 percent is lower than fourth quarter 2008’s 6.8 percent rate. The Consumer Price Index dropped 1.6 percent year-toyear in February, the first negative growth rate in six years. Leading investment banks have downgraded their forecasts for China’s growth, from 7.5 percent to 5.5 percent. To combat plunging global demand, domestic exporters are selling goods to the Chinese market, creating deflationary pressure.

These new indicators and forecasts provide a perspective on three challenges China must overcome to achieve its goal of 8 percent growth in 2009.

Reinvigorate the real estate market. The real estate market, critical to stimulating China’s economic growth, is expected to be lethargic near term, as a weakened economy drags down employment and presages the likelihood of salary cuts. Property prices in 70 major Chinese cities fell 0.9 percent compared to a year ago and 0.2 percent from December. Simultaneously, real estate investment has slowed, falling 21 percent in the second half of 2008 after increasing 33 percent in the first half of 2008. Although prices are expected to stabilize this year, they are not expected to surge, suggesting a recovery that could take months, if not years.

Don’t forget small and mid-sized companies. The majority of the stimulus package will go toward helping local state-owned enterprises and the public sector, particularly in the area of infrastructure construction. If small and mid-sized companies are left behind, it could lower the effectiveness of the stimulus package and inhibit growth of the economy as a whole.

Create enough jobs and capital to put back into the economy. Consumers have to start consuming again. This might require months, or years, to generate meaningful domestic demand. Consumers’ concerns over job security and inclination to save rather than to spend can curb consumption. However, Morgan Stanley recently adjusted its forecast for consumption to become a larger portion of GDP growth (from 50.7 percent to 54.5 percent), highlighting the expectation that domestic demand will become the principal driver of growth as demand for exports continues to decline.

Despite dreary forecasts and challenges to recovery, analysts are relatively optimistic that China’s economy will begin to turn around in the second half of 2009. If the central government increases its stimulus package, it’s possible that China’s shivering dragon—its economy—can refocus, recuperate and regain its robust rate of growth.

Dr. Bernhard Hartmann is a partner and managing director of A.T. Kearney’s Greater China region, based in the firm’s Shanghai office. He can be reached at This e-mail address is being protected from spambots. You need JavaScript enabled to view it . A.T. Kearney consultants Rong Wang, Tammy Ku and Kevin Xu also contributed to the article.

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The views expressed in this paper are those of the author(s) and do not necessarily represent the views of A.T. Kearney or the Global Business Policy Council. The views are not meant to suggest specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinion.

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