The Rupp Report: China: A Return To Economic Reality?

From the latest economic news from China, it is obvious that the great country is in a process of
rethinking: The National Bureau of Statistics of China recently published economic data for the
third quarter, reporting that the gross domestic product (GDP) rose 7.4 percent – the lowest gain
since early 2009. On the other hand, there are also signs of a recovery in the Chinese economy,
which would be more than welcomed by the Western textile machinery industry.

The Leap Into The Modern Age

In the last 35 years, China has experienced a tremendous leap in development. The “father” of
this development was Deng Xiaoping, who turned the Chinese people and economy upside-down. Deng
initiated this jump in December 1978.

Deng’s effort to bring China out of its isolated position was a veritable U-turn from the
up-until-then practiced communism, and opened all gates in the direction of pure capitalism. What
China achieved with its new economic power is well known in the textile and textile machinery
industry; Mainland China became the largest global player. From the 1980s onward, the GDP rose by
10 percent annually, often even higher. These figures, by Western standards almost astronomical,
resulted in an almost obsessive race among the different provinces of China to achieve large growth
rates. This competition for the favor of the central government has led to some serious mistakes
and to the well-known results: The growth rates are falling. This race couldn’t go on forever.

The Miracle Shenzhen

From 1979 on, Deng also initiated the special economic zones in the cities of Shenzhen,
Xiamen, Shantou and Zhuhai. This strategy was totally the opposite of Mao Zedong’s older policy.
Likewise, Chinese businesses were allowed to accept foreign investment, import foreign goods and
know-how, and export their own products. The author visited Shenzhen for the first time in the late
1980s. Shenzhen is about two hours’ drive away from Hong Kong. At that time, this place was more a
hick town in the Pearl River Delta, and no one knew what would happen in the future. From 1987 on,
private companies were registered in these special economic zones, which led to a tremendous boom
of production. Whoever comes to Shenzhen these days, where the population currently totals about 12
million to 14 million, can hardly imagine the development of this city in such a short time. The
resulting inflation and the problems of 1989 triggered a dramatic step backward and, for example,
resulted in the stop of the economic process. But also here, Deng Xiaoping got the solution: In
1992, he went to southern China to kick-off the reforms again.

The Avalanche Rolls

Over the next 20 years, China started booming and became the second-largest economy in the
world, in absolute GDP terms. In order to meet the rapid development, little consideration was
given to social and regional imbalances, or to natural resources. On top of that, the development
focused for a long time on the east coast and southern China. The companies in the Pearl River
Delta in Guangdong Province produce mostly for export. The share of exports vis-à-vis GDP has
increased more and more in the last 10 years. Exports have benefited until now from very low wages
and an undervalued currency to make them attractive.

However, this process enlarged the differences between the provinces, which fueled the
tensions further. The problems that China is facing now are well known and are similar to those of
the Western world: These include the euro crisis, rising energy and labor costs, and social unrest,
mainly because the different provinces in the large country have completely different labor cost

When the exports collapsed in fall 2008 because of the global financial crisis, the
government granted a multi-billion-renminbi stimulus package to save the economy from crashing and
to prevent having too many unemployed people. First, there was a lot of praise for these actions.
However, today, the people involved in setting this policy know that not everything was positive.
These facts were also repeatedly confirmed by leaders of the Western textile machinery industry.
For example, there was no limit on the availability of money, and many new factories sprung up like
mushrooms in the fields.

However, people often wondered how it would end if entrepreneurs from other sectors invested
in textile industry. And then, as in the Western world, local governments suddenly found themselves
in financial trouble. There were many bad loans from banks, and this led to severe inflation. This
situation did not apply to state-owned enterprises: They got money at low interest rates. Private
companies had, and have, a much more difficult task to get the money, which led to further
problems. This development nourished doubts on the unlimited export-oriented growth model of the
Chinese economy.

The Turning Back

Today, China is in the midst of a reorientation of its economic policy. Published economic
data for the third quarter show a 7.4-percent GDP growth rate, the lowest level since early 2009.
At the same time, the demographics of the country have changed, as the older generation is living
longer and there are already shortages in the labor market. Currently, more than half of the
population lives in urban areas.

The Chinese government already knows that the old economic model has become obsolete. The
12th five-year plan from 2011 said goodbye to unbridled growth. Not quantity, but quality of growth
is in the focus of attention. This includes hot issues such as sustainability, environmental
protection and reduced use of natural resources. The fact that China still wants to reduce its
dependence on exports could become an issue in terms of limited supply for large Western retailers.

Bottomed Out?

Although China’s economic growth in the third quarter fell to its lowest level since 2009,
people are relieved: The 7.4-percent GDP growth is close to the 7.5-percent target set by the
government for 2012. Despite the global financial and political situation, Chinese officials are
positive, considering the developments from the second and third quarters. It is reported that the
quarter-to-quarter GDP grew 2.2 percent faster than the previous comparative periods.

In addition, in September, industrial production grew by 9.2 percent, more strongly than in
the previous month, which recorded 8.9-percent growth. This was mainly due to investments in
infrastructure. But whether this will lead to a new bubble remains an open question. Particularly
important is the consumer mood. Here, official sources report that the consumption share of the GDP
in the first nine months is stronger than the investment share. Remarkable is the fact that the
service sector is increasing in importance. On the other hand, production sites in south and east
China are complaining of bad Christmas business.

And Now?

Despite intensive efforts to stimulate the domestic market, China remains an exporting
country. This is evident above all in the textile manufacturing industry. In the coming years,
China will vastly increase the production of man-made fibers, especially polyester. And this
production can’t all be further processed domestically. As the Rupp Report reported following ITMA
Asia, the Chinese are very much concerned about the situation in the eurozone. However, anyone who
knows the Chinese mentality is certain that the Chinese, with their common sense of business, will
circumnavigate these cliffs and will be even stronger than ever after this difficult time.

October 30, 2012