A copper price collapse of more than 60 percent, zinc cut by up to a half and oil down to $70 a barrel. That’s the fate facing world commodity markets should China’s growth dip to 3 percent in the next three years -- a scenario economists at Barclays Plc (BARC) are now examining.
They’re not the only ones building models based on a steep decline in growth in the world’s second-biggest economy. Nomura Holdings Inc. (8604) estimates a one-in-three chance of a sharp drop by the end of 2014, and Societe Generale SA sees a “non-negligible risk” of less than 6 percent growth this year and an outside chance of 3 percent average expansion for this half and next.
Premier Li Keqiang’s efforts to rein in a record credit boom, avert a property-price bubble and strengthen environmental protections risk deepening China’s slowdown and adding to drags on the global economic recovery. With growth already heading for a 23-year low, a hard landing would batter commodity markets, hurting mineral exporters like Australia, Brazil and South Africa, and miners such as BHP Billiton Ltd. (BHP) and Rio Tinto Group, that have begun to slow expansion.
“This is a very delicate thing they’re trying to do because to slow gradually is very difficult, partly because it’s a self-enforcing mechanism and it can become a vicious cycle,” said Andrew Polk, an economist in Beijing with the Conference Board, a New York-based research group, who sees average growth of 5.5 percent over the next five years. “There’s a distinct possibility that the slowdown could get out of control and the risk of a policy misstep cannot be discounted.”
Barclays analysts Sudakshina Unnikrishnan and Jian Chang outlined a growth risk scenario in their July 5 report brought on by slowing industrial production and growing risks of financial stress due to build-up of debt by companies and local governments. They also point to the implementation of Likonomics -- a term describing the market-reform policies of China’s premier -- as possibly inflicting short-term pain on the economy even as it sets growth on a healthier long-term trajectory.
China’s growth slowed for a second straight quarter to 7.5 percent in April-to-June, extending the longest streak of expansion below 8 percent in at least two decades. Manufacturing weakened further in July, according to a preliminary survey of purchasing managers, signaling that the nation’s slowdown hasn’t ended.
“Policy is still evolving and it’s quite hard to envisage when exactly” a hard landing would happen, Unnikrishnan said. “The recent data has been rather negative and that’s caused a lot more people to get cautious.”
The Chinese government in March set a 2013 growth target of 7.5 percent and has a goal for an average 7 percent expansion during its current five-year plan that runs through 2015. China hasn’t grown less than 7.6 percent since 1990. (CNGDPC$Y)
“I don’t know if the world is ready for China’s growth below 7 percent but it’s not realistic to think of a country growing at 10 percent, even 8 percent for decades in a row,” said Orville Schell, director of the Center on U.S.-China Relations at the Asia Society in New York. “The Chinese economy too is mortal and ultimately will be subject to the same kinds of cyclical growth as every other economy.”
Li said recently that policy makers’ bottom line for growth is 7 percent. The government announced support measures July 24 in the form of accelerated rail construction in the country’s central and western regions, and tax breaks for small companies.
“They certainly want enough growth to maintain social stability and prevent the economy from a more serious shortfall,” said Stephen Roach, former chief economist at Morgan Stanley. Roach, who is now a senior fellow at Yale University’s Jackson Institute of Global Affairs, said he’s “not in the hard landing camp.”
The notion of a soft or hard landing is “simplistic,” said Jim O’Neill, the former Goldman Sachs Group Inc. economist who coined the term BRIC and is now a Bloomberg View columnist. China is “adjusting in the right direction” and this can be gauged by studying the relationship between real retail sales and industrial production, which he said he watches every month.
“It is reasonable that they can achieve 7.5 percent growth this year and indeed this decade,” O’Neill said in an e-mail. “At 7.5 percent this is equivalent to the U.S. growing by 4 percent in terms of world contribution, so any further Chinese slowing would be big.”
China’s thirst for commodities has made it the world’s biggest buyer of industrial metals and the largest energy consumer. It used 646 million metric tons of steel in 2012, more than twice the rest of the Asia region combined. In recent years it has ousted the U.S. as the top trade partner for Brazil and Chile, with almost 90 percent of the $41 billion of Brazilian exports (CNFREXPY) to China last year deriving from commodities.
As China’s economy has cooled, commodity prices have slid. Iron ore has slumped 17 percent since reaching a 16-month high in February. Ore for immediate delivery at Tianjin port in China traded at $132.60 a dry metric ton on July 26, down from $158.90 reached Feb. 20, according to The Steel Index Ltd., a gauge for iron ore prices.
The Standard & Poor’s GSCI Spot Index (SPGSCI), a gauge of 24 raw materials, lost 4.7 percent in April, the most since a 13 percent plunge in May last year. The Bloomberg World Mining Index, whose 115 members include BHP, Anglo American Plc (AAL) and Rio, has slumped 28 percent this year, while the S&P 500 has climbed more than 18 percent in the same period.
In the case of a hard landing, Societe Generale’s investment recommendations are to sell copper call options and buy copper puts, buy the U.S. dollar and Treasuries, and sell the Russian ruble, South African rand and the Chilean peso. Sellers of call options and buyers of puts profit if prices fall.
A growth rate in China of 5.9 percent in 2014 would lead metal prices to fall as much as 30 percent, while oil prices may drop as much as 20 percent, according to an estimate by Nomura in a July 23 report. Brent oil for September settlement traded at $107.13 a barrel today on the London-based ICE Futures Europe exchange, down about 10 percent from its peak this year.
Kevin Rudd, Australia’s new prime minister, spoke June 28 in Canberra about the end of a China-fueled mining boom that has powered average annual growth in his country of 3 percent over the past decade, and which he said would have “a dramatic effect on living standards in the country.” He said that trade with China makes up about 10 percent of his country’s GDP.
Australia, the world’s biggest shipper of iron ore, cut its forecast in June for earnings from exports of minerals and energy after prices tumbled. The Bureau of Resources and Energy Economics said June 26 that earnings were set to total A$177 billion ($164 billion) in the year ended June 30, less than the A$186 billion previously estimated and the first decline since 2009-2010.
South African Reserve Bank Governor Gill Marcus on July 18 said that slower growth in China had “impacted negatively” on commodity prices. In the five months through May, South Africa exported 43.1 billion rand ($4.4 billion) worth of goods to China. Mineral products accounted for 34.3 billion rand and base metals for 3.6 billion rand, according to the South African Revenue Service.
“It is incumbent on those countries to undertake their own structural reforms so that they aren’t completely reliant on commodity exports,” said Polk, referring to the world’s main commodity producers. “Australians talk about this all the time, that they are overly reliant on China and the export trade, and haven’t done enough to diversify their own economy. It will hurt them.”
Mining companies across the globe including BHP, the world’s biggest, Rio and Glencore Xstrata Plc (GLEN) have deferred projects and cut spending amid the price slump. Vale SA (VALE3), Brazil’s largest exporter, sells almost 50 percent of its iron ore shipments to China and its shares are among the worst-performing major mining stocks this year as China’s steel demand growth has waned.
BHP in August 2012 put on hold approvals for about $68 billion of projects including the Olympic Dam copper-uranium mine expansion in South Australia and an iron ore port expansion in Western Australia. Glencore Xstrata, the world’s largest shipper of thermal coal, in May halted work on a 35-million-metric-ton coal port in Australia because of overcapacity and a poor market.
Rio, which is scheduled to report first-half earnings Aug. 8, may see net income drop 18 percent to $4.8 billion for the period, according to the average of four estimates compiled by Bloomberg. BHP, scheduled to release full-year earnings on Aug. 20, may report a 21 percent drop in net income to $12.2 billion, according to the average of 17 estimates compiled by Bloomberg.
BHP sees growth in China, its largest customer, moderating toward 6 percent after two years. Chief Financial Officer Graham Kerr said in April at the Bloomberg Australia Economic Summit that he didn’t expect “double digit growth rates to continue” and that the “biggest risk is clearly from our perspective what happens in China.”
Nomura estimated in a July 23 report that a Chinese growth rate of 5.9 percent in 2014 would trim 0.3 percentage point from world economic growth, while Societe Generale estimated in a report this month that 1.5 points would be shaved off global expansion in the first year of a hard landing.
Premier Li has signaled he is willing to endure slower growth as he weans the economy off exports and cheap credit, and steers it toward a more market-driven path with a reduced role for government. The central bank engineered a cash crunch last month that sent the overnight interbank lending rate to a record 12.85 percent in an attempt to rein in speculative loans.
The government on July 25 ordered more than 1,400 companies in 19 industries to cut excess production capacity this year. Steel, ferroalloys, cement and copper smelting were among the industries identified by the Ministry of Industry and Information Technology. The State Council ordered a nationwide check of government debt, the National Audit Office said in a statement yesterday.
While Barclays said a scenario in which quarterly growth drops “briefly” to 3 percent at some point in the next three years was “increasingly likely,” its baseline view is for 7.4 percent growth this year and next. Even if growth did slow that much, “the economy would bounce back rapidly afterwards,” the report said.
Nomura’s baseline forecast for 2014 is 6.9 percent growth. There is a one-in-three chance that GDP will drop below 5 percent for four consecutive quarters starting at or before the fourth quarter of 2014, said Zhang Zhiwei, chief China economist in Hong Kong.
Recent economic data suggests the slowdown is continuing, casting doubt on whether the government will achieve its annual growth target. Exports were down 3.1 percent in June from a year earlier, the most since the global financial crisis, and industrial production rose a less-than-forecast 8.9 percent in the same month.
“China is a gray swan, not a black one, because a hard landing won’t be totally unexpected and there may be a recession sooner or later,” said Alaistair Chan, a Sydney-based economist for Moody’s Analytics. “If that happens, it’s not going to be pretty for commodity exporters in the short run.”
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