China’s growth outlook remains a concern

This article is part of
Spring Investment Monitor - March 2013

Data from the Organisation for Economic Co-operation and Development (OECD) forecasts a 0.1 per cent contraction in Europe’s GDP growth this year, and only moderate GDP growth in emerging market heavyweights China and India.

The emerging markets have been the growth story of the past few years. As the developed world plunged into recession, these economies surged forward.

In 2007 for example, when the UK saw GDP growth of 3.6 per cent and US growth slowed to just 1.9 per cent, China saw a rapid escalation to 14.2 per cent. In the same year, India’s GDP growth reached 10 per cent.

GDP growth in these regions has slowed, with the OECD’s prediction for India’s 2013 growth sitting at 5.9 per cent, almost half of that seen in 2007. China, meanwhile, is expected to grow by just one percentage point this year.

Adrian Lowcock, senior investment manager at Hargreaves Lansdown, says: “Investors were put off the region because Chinese equities have lagged their peers since the financial crisis. Prior to the crisis China was expensive but it now compares favourably with other Asian markets.

“Today the price-to-earnings ratio for the MSCI China index is 8.5. Compared with historical levels the ratio looks attractive. It was last at these levels in 2000 shortly after the dotcom bubble burst and prior to that in 1997 following the Asian Crisis.”

But M&G fixed income manager Mike Riddell remains concerned on the outlook for Chinese growth. “The IMF has long been warning of the threat posed to global financial stability by the great Chinese credit bubble, and their study on global spillovers makes interesting reading,” he says.

“They estimate that for each percentage point deceleration in China’s investment growth, 0.5-0.9 per cent is subtracted from GDP growth in regional supply chain economies such as Taiwan, Korea and Malaysia. Commodity producers such as Chile and Saudi Arabia are also likely to suffer substantial growth declines while countries such as Canada and Brazil would experience ‘somewhat significant output loss and slowdown’.

“There would be ‘a substantial impact on capital goods manufacturing economies such as Germany and Japan’, and one year after the shock, commodity prices, especially metal prices, could fall by 0.8-2.2 per cent from the baseline levels for every 1 per cent drop in China’s investment rate.”

He adds that should China see a drop in investment growth from 13.5 per cent to 4.5 per cent, as suggested by the IMF, such a rebalancing and slowdown could easily develop into an Asian/emerging market financial crisis. “If you want to get extra gloomy, you can also consider that such a large economic shock would also be accompanied by a reversal of the huge decade-long EM equity and bond inflows to the region, which is something else that the IMF has repeatedly warned about,” he adds.

Among the developed economies, data suggests that Europe will be the last to recover from years of negative growth. This, according to the OECD, will happen in 2014 when GDP growth is forecast to reach 1.3 per cent.