At the end of 2018, the world's second-largest economy slid further into a slowdown. Geopolitical events - including the US-China trade war - have compounded matters. Still, the actual cause is more complex, thanks to the impact of government policy and structural shifts in the economy. This post will examine what's going on and what implications exist for the Asian supply chain.
Chinese Supply Chain Slowdown: a Recap
In 2011, China began to show signs of departing from its upward trending growth rate.
Its export orders weakened, banks tightened their lending limits and the government reacted with monetary and fiscal measures to boost the economy. The situation surprised the notoriously booming country, which had boasted annual growth of over 8% since the mid-90s.
China lingered in this state of slowdown until 2017 when growth surpassed market expectations at 6.9%. This was the first true sign of acceleration in seven years. Thanks to investments in infrastructure and a high-speed rail network it appeared that the slowdown had run its course.
However, it wasn't the case because in 2018 the Chinese economy reported the slowest growth rate in 28 years.
Industrial production slowed, car sales and other retail purchases declined and the unemployment rate hiked.
These are tell-tale signs of a downward economic cycle. Why is this happening and will the recently announced measures by the National People's Congress be enough to bring relief?
The Roots of China's Economic Slowdown
The Chinese economy has always been hard to measure. It is driven by political initiatives, making it challenging to analyse the numbers objectively and determine the cause of this slowdown.
Despite the unique complexities, the slowdown can be attributed to at least four factors.
- Decelerating Global Economy
China isn't the only economy facing a slowdown. Europe, the UK, Japan and several emerging markets are experiencing similar situations. The global economy has stepped on the brakes, as reflected in the drop-off in world trade growth (nearly 0% at the end of 2018!)
Risks are prevalent. Financial conditions across the board are tightening. The sentiment is negative. Consumers and companies are wary.
Despite an increase in isolationist policies, the global economy is undeniably interconnected. What's happening in Europe - including the uncertainty over Brexit - indirectly impacts China. People and organisations are waiting to see what will happen next and are holding off on spending, which means the rest of the world is demanding fewer Chinese manufactured goods.
While the US-China trade war is not the sole reason for the slowdown, it is not helping the situation.
The $250 billion (USD) tariffs applied to China have added pressure on its economic health. China must balance them as it attempts to support growth and stabilise markets.
That's why March's National People's Congress announced several measures to defuse the trade war:
- increasing foreign companies' access to markets;
- reducing the number of closed sectors; and
- shoring up intellectual property laws.
Hopefully, as these resolutions develop, trade tensions will ease, and the economy will be in a better position for relief.
After years of investing in infrastructure to lift its growth rate, China has accumulated significant debt. To make matters worse, companies and consumers in China are also drowning in debt because of the cost of living.
The government injected more cash into the economy to raise consumer confidence and boost consumption. But the extra money floating around only increased inflation. Chinese consumers continue to suffer from the broadening money supply.
This situation is the definition of a negative feedback loop. In an attempt to reverse debt, China as a whole has inadvertently gone into even more.
China has shifted its priorities now that its economic slowdown has become a visible issue. It is now pushing for a higher growth rate, which means a return to debt-inducing activities that further strain the country and its constituents long-term.
The Chinese government's plans to ease back into growth include spending more on infrastructure, putting more money into circulation, encouraging bank lending and cutting taxes. All are possibilities that continue to increase their liabilities.
These acts of stimulus in 2018 (and planned for 2019) are not convincing economists. Pumping more money into the economy has led to a fiscal deficit rather than a reignition of growth. The ROI of government spending is proportionally lower because the Chinese economy is so large.
So, this excessive debt isn't helping the situation at all. It's leading to slower growth and higher burdens for consumers and companies alike.
Despite what some policies suggest, China recognises its issue with debt. The government has made a commitment to deleveraging but plans for more stimuli at the same time.
These initiatives are at odds with each other, emphasising the Chinese economy's difficulties. China has ambitions to hit growth targets while reducing debt. Nothing is achieved by switching between these initiatives. The Chinese economy is struggling to find the balance it needs between growth and sustainability.
So, why is this troublesome?
After the 2008 financial crisis, China served as one of the few engines of growth for the global economy. So as China goes down, the rest of the world is at risk of the same fate.
There's no question that Asian Suppliers are hurting in such an environment. Let's take a look at what they can do to shift terms in their favour.
The Impact of China's Economic Slowdown on Suppliers
Small manufacturers in China have been hit particularly hard by the economic slowdown.
This is mainly due to a working capital squeeze which has put many manufacturers out of business.
Drop in Supplier Demand
China's manufacturing regions have historically boomed but the lack of current demand creates issues for Exporters (Suppliers).
At the end of 2018, many Exporters 'front-loaded' their operations. They hiked production levels and shipments to fill orders before the Chinese New Year and in anticipation of an increase in tariffs.
But following this spike, Exporters faced a considerable drop-off. Now, there are fewer orders to fill.
In February, Chinese exports plunged by over 20% (in US dollar terms) compared to the year before. While exports typically dip during this time thanks to factory closings for the Chinese New Year, the numbers are more drastic than usual.
This puts small Exporters at risk of going out of business. Production is low, orders are minimal and employees are at risk of redundancy.
Loss of Business
Buyers worldwide are reconsidering their supply chains to avoid working with Chinese Suppliers.
Many Suppliers are losing out on business because they are not established enough to make demands of their own. This forces them to scale back production further, stretching cash flow to the limit.
Lack of Funding
Under the guise of 'supply-side reform', China has focused on cutting industrial overcapacity. It's also tried to improve the quality of economic growth, which has pushed many steel mills, coal miners and other Suppliers out of business.
The government's financial de-risking campaign discourages banks from lending to SMEs. In this attempt to improve quality, many small Suppliers - who already struggle to receive financing in normal conditions - cannot receive funds due to perceived levels of risk.
A Solution for Suppliers - A/R Financing
Despite the dire outlook, Suppliers need not suffer unnecessarily. They can take contracts into their own hands and save their business even during an economic slowdown. One answer lies in accounts receivable financing.
- When banks won't finance, A/R financing gives Suppliers money up front, keeping their operations alive in the short run (and helping them invest to stay afloat in the long run).
- When Buyers refuse to work with them, A/R financing lets them offer attractive extended payment terms, making them more appealing to work with.
- When Buyers might hold off payment to keep their own cash flowing, non-recourse A/R financing protects Supplier against non-payment.
- When Buyers might not pay, A/R offers guaranteed payment to Suppliers.
© Stenn International Ltd. All rights reserved. Any redistribution or reproduction of part or all of the contents in any form is prohibited other than the following:
- You may copy the content to your website page but only if you acknowledge this website as the source of the material and provide a backlink to this article.
- You may not, except with our express written permission, distribute or commercially exploit the content in any other way.
Disclaimer: The above article has been prepared on the basis of Stenn's understanding of the subject. It is for information only and doesn't constitute advice or recommendation. Whilst every care has been taken in preparing this article, we cannot guarantee that inaccuracies will not occur. Stenn International Ltd. will not be held responsible for any loss, damage or inconvenience caused as a result of anything published above. All those applying for credit should seek professional advice when doing so.