China growth problems are ‘here and now’, says Catella manager

Henrik Holmer, manager of the Catella Nordic Tiger fund, has said the challenges facing China’s growth trend and other issues such as wage inflation, expanding debt, and the housing market bubble are all very much in the present rather than factors that can be discounted into the future.

Holmer has recently returned from a week long trip to Beijing, Shanghai and Hong Kong, where he met both Nordic companies active in the country as well as domestic Chinese companies.

He said the key themes that were touched on at almost ever meeting included: the lower growth rate; growth coming from consumption and services, wage inflation, expanding debt, the housing bubble, Chinese competition, low capacity utilisation and environmental problems.

“We have been reading about these themes for a long time now, but there was a consensus view that the problems are here and now,” he said.

Economic growth is expected to be in the range of 6-8%. The problem is that many companies had based their assumptions on a higher rate of 10%. This suggests bankruptcies ahead. If growth drops below 5% it will lead to high unemployment, Holmer warned.

It is important to remember, however, that China is not one homogeneous market. Some regions in the country grew by 17% last year, while Shanghai grew by 5%.

The key is confidence. Holmer said that Chinese people are confident that the government will maintain growth, but if that confidence fails then he predicts many rich Chinese will move to the West.

One challenge for local businesses is wage costs. These are rising 10-15% annually, while the government has said that the minimum wage should rise by 10% annually until 2015.

“Blue collar wages still make up a small proportion of costs for Nordic engineering companines, but if they continue to increase at the current rate this will lead to more automation and optimisation of production. Wages for middle and high level managers are at the same level as in Sweden since the expertise of Chinese managers has improved. Fixed salaries in particular have increased. Variable remuneration is paid in certain industries, but this has decresed in recent years since it is dependent on factors such as overtime and sales volume,” Holmer said.
Wage pressures are even more intense in other industries. “Clothing companies that we met are more concerned about wage inflation than raw material costs,” he added.

Lending is another area of concern. Lending grew by 58% across all types of financing in the first quarter of 2013, according to the figures published by Catella. But it is estimated that much of this is being used to repay other loans. China’s debt financing helped it weather the financial crisis, but it is not as simple as saying higher lending is creating a housing bubble, even though much of the credit was used to construct property.

Most of the loans have gone to state owned enterprises ratehr than increasing consumer debt. What is most worrying, however, is the growth in shadow banking, especially so-called trust loans – loans repackaged into investment products and sold to private investors.

“The money then goes to infrastructure loans, local governments and equities. These trust loans were up 458% y-o-y in January -April this year,” Holmer said.

“Several of the companies we met have started to note increasingly strained liquidity among customers. This has in turn led to the Nordic companies now conducting tougher credit analysis and requiring payment relatively quickly. However, this means that they can lose customers since many local competitors offer generous credit terms.”

Another challenge to Nordic companies selling in China is growing domestic competition, which is moving up the value chain. Although there are barriers such as better transparency, R&D, technology and aftermarket services, Chinese companies can benefit from offering more generous credit terms, the ability to operate amongst corruption and bribery – which Nordic companies avoid – as well as the propensity for Chinese to prefer buying Chinese.

Other challenges to China include capacity utilisation and environmental considerations.

Utilisation averages have dropped from 80% to 60%, and it is most visible in areas such as wind power, steel, paper, mining and real estate.

Environmental problems are rife, despite a strong central government commitment to strict rules. The problem is lax enforcement at the local level, Holmer said. “If local governments want to, they can find loopholes to escape the regulations.”

For Nordic companies operating in China, it seems as though those most able to adjust to local conditions are best positioned for growing faster than the overall economy. Holmer said he met with Trelleborg and Volvo Construction Equipment, both of which are committed to being flexible in their local businesses, for example, to increase or decrease production output of constrution equipment depending on demand fluctuations.


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