International | Dec 19 2006
By Greg Peel
Two fundamental factors within the story of the great Chinese economic explosion have been efficiency and financing.
In the case of the former, China’s headlong rush into industrialisation has been achieved without time for attention to efficiency, and if you have a population exceeding one billion, and a world ready to throw every commodity under the sun at you, just how efficient do you need to be?
In the case of the latter, the corporations of mature economies tend to try to keep their borrowings and equity raisings to within balanced limits and fund expansion with retained earnings whenever possible. In China, banks have been falling over themselves to lend to the country’s one thousandth new ball bearing factory at artificially low rates of interest. Profit margins have been barely existent, so there’s no time to wait around for earnings to accumulate.
Both these factors are often touted as requiring immediate attention from the Chinese government. China is consuming commodities and polluting the world at a rate many times more per capita than that of western nations. And the propensity for banks to provide easy money is just creating the non-performing loans of the future. To avoid an economic blow out, and a crash landing, steps must be taken.
The Chinese government is claiming to be working on the problem, and the World Bank claims results are being seen. As efficiencies are improving, profit margins are increasing, leading to the capacity to fund expansion without approaching the bank.
Those on the ground believe this claim is a load of rubbish. Macquarie follows up the argument.
The only profit margins that have risen in China are those of commodity producer companies, due to the rise in commodity prices. Manufacturing margins are still falling. Labour and land costs are on the rise.
Only larger, more successful firms are de-leveraging. Smaller firms, living on the margin, are increasing their borrowings in order to survive. The banking industry is increasingly more exposed to weaker companies. Smaller banks have no contact with blue chips.
Macquarie also suggests that overinvestment is not as much of a problem as the Chinese government thinks. While margins might be falling, revenues are increasing. This increases “asset turn” (the amount of revenues generated from assets held) and allows for de-leveraging despite low profits. Capital utilisation is actually rising.
What all this means is that those looking for a healthy easing in economic growth and an increase in return on Chinese equity are probably kidding themselves, as far as Macquarie is concerned. Chinese GDP growth is still strong, and the upside for returns looks slim.
