The strike in the Honda factories in China and the spate of worker suicides at Foxconn have turned the spotlight on China away from property prices, bubbles and government tightening measures towards the state of the labour market. Some significant changes are expected.
Wages are going to be increased at Honda factories in China to the tune of 24%. Foxconn, that makes the consoles for iPods and other Apple products, is set to increase them by 30%. Many provinces are expected to raise minimum wages by at least 20%. Beijing Municipality has already done so. Deutsche Bank has done some quick simulation based on the assumptions of a 10% wage increase (beyond their 10% baseline projections) in 13 low-end labour-intensive sectors. Based on the simulation, 10% wage inflation in labour-intensive sectors would push up the consumer price index by 0.4%, reduce real gross domestic product (GDP) growth by 0.1% and reduce employment by around 700,000 jobs.
This sounds a bit drastic, but one has to acknowledge that wages are going up because there are emerging labour shortages and, therefore, the extent of job-losses anticipated due to the increase in minimum wages could be overstated. Further, many of us have been waiting for this to happen. Therefore, it is only appropriate that we acknowledge what is happening in China.
China has for long built its economic prosperity based on being a low-cost production centre for multinationals. We have argued that this model has outlived its time and that China had to foster greater domestic consumption. We had also stressed that the route to such a higher share of domestic consumption in the national GDP was through higher wages. Hence we need to cheer this development.
China’s nominal effective exchange rate has appreciated in recent times due to the ongoing depreciation of the euro against other currencies. With the de facto pegging of the Chinese yuan to the US dollar at 6.82-6.83, the weakness in euro-dollar translates into weakness in euro-yuan. In other words, stronger yuan. On top of this, we now have wage increases. This would further cause the real effective exchange rate of the yuan to appreciate. It might hurt China’s export competitiveness at the margin. But isn’t it what other nations and the global economy wanted—a rebalancing of China’s growth away from exports and more towards domestic demand?
Where are the risks? The risk—that some might be anticipating—that this development of worker protests would give rise to a broader labour unrest and thus threaten social stability—does not appear to be serious. It is a remote prospect, for now.
The other key risk for China comes from the impact on inflation from higher consumption now that workers find themselves with higher wages. This could, in conjunction with excess liquidity, cause a rapid escalation in inflation in the second half of the year. In a recent research note, Credit Suisse claims that excess liquidity in the system in China remains sizeable and it is in search of the next bubble, after having moved from the stock market to property to garlic (yes, garlic). Now it could be the turn of pork. It might not have adverse implications for systemic stability like a stock market or a property bubble but its implication for inflation would be considerably adverse. On top of this, a recent news-item in Caixin magazine provides the following sobering information on the finances of local governments and the funding vehicles (“platforms”) they had set up:
• Banks are generally in the dark about the revenue, expenditure and debt situations facing the local governments they deal with
• They also don’t have access to current information to determine whether a government has reached or surpassed debt limits.
• Some local government officials closely guard financial information, while others simply fail to keep proper records
• Among the facts that are known is that the average ratio of platform loans to total fiscal revenues at local governments is 97.8%, said a source at the China Banking Regulatory Commission
• Ratios for some urban investment platforms exceed 200%. Moreover, these ratios do not account for other forms of local debt
In other words, China still faces some heavy battles in its quest to achieve a better balance between external and domestic orientation, between bubbles and booms and between economic growth and inflation.
If it succeeds—the current odds are tilted in favour of it succeeding in this cycle, even if only marginally—then it would strengthen the case for investment benchmarks to be revised in favour of greater allocation for emerging markets.
If China stumbles, it would not just be the universe of emerging markets and commodity producers that would be hurt. With the Group of Twenty ministerial meeting producing verbal diarrhoea and signalling that each of them is going to pursue their own method, the West had better not bet on Hugh Hendry being correct with his China crash thesis.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org