Key Takeaways:
China's domestic economic issues, coupled with a slowing global economy, are currently driving a significant decline in both exports and imports.
Fewer imports may lead to price reductions for commodities such as steel and aluminum while prompting greater volatility in shipping costs.
Reduced demand for Chinese exports could lower the prices of Chinese goods, offer increased bargaining power for international buyers, and potentially lead to longer supply chain lead times due to the instability.
Monitoring the ongoing economic situation in China and understanding its impact on global pricing and supply chains are critically important for future strategic procurement decisions.
China is a pillar of global trade, serving as the largest trading partner of over 120 countries and constituting 30% of global manufacturing output. With the Chinese economy stymied by intermittent lockdowns, Beijing’s abandonment of its zero-COVID policy at the turn of the year was met with great optimism. At last, the economy began to show signs of strength as consumer spending, exports, and imports received a much-needed boost. The government officially set a 5% GDP growth target for 2023, and analysts widely expected to see this conservative estimate surpassed.
Fast forward to the Summer of 2023, and the rosy picture of China’s economy has dimmed. As the country faces a slew of macroeconomic issues that continue to disrupt the economy, procurement professionals abroad are now tasked with preparing for potential ripple effects on the global economy. What's happening to China's economy, and how does this impact procurement?
Why are Chinese imports declining?
With the end of lockdowns, analysts expected the pent-up consumer demand to spearhead China's economic recovery. Yet imports to China have decreased 12.4% year on year in July and 8.8% in August. What’s going wrong?
To understand the decrease in imports, we must examine consumer sentiment in the country and its impact on the economy. Of particular importance is the significant influence of the property sector.
- In China, property accounts for an immense percentage of household wealth at 70%, nearing 80% in larger cities.
- The price-to-income ratio for buying a house in China exceeds 30:1, dwarfing that of the United States at closer to 5:1.
- The property sector is the most substantial contributor to China’s GDP, making up 30% of the overall economy – a percentage that is nearly twice that of other major economies.
With anxieties over a burgeoning real estate bubble, the government introduced the “three red lines” policy to combat speculative investments. The "three red lines" benchmark set restrictions on debt-to-assets and debt-to-equity ratios while requiring property developers to divulge further details on their debt positions. In effect, this policy triggered defaults (Evergrande) and record net losses (Country Garden) from some of the country’s largest developers, as well as a liquidity crunch for major trusts and investment groups (Zhongrong).
In China, 90% of properties are sold before they are completed. Amid the liquidity crisis, several homebuyers are on the hook for unfinished properties sold to them by financially strapped developers with indefinite timelines, if any, for the completion of these projects. In the face of these economic uncertainties and concerns over the health of the real estate market, new home sales declined 33% year on year in July, and the value of both new and existing homes continues to fall.
This is only one challenge China is facing. The youth unemployment rate in China has risen every month in 2023, standing at 21.3% in June before the government ceased publishing these statistics. Consumer prices declined 0.3% year-on-year in July, which, accompanied by high unemployment, has led to mounting concerns about stagflation. $9 trillion of off-balance-sheet debt continues to burden local governments.
Amid such uncertainty and turmoil, Chinese citizens have and will continue to prioritize saving over spending, regardless of governmental efforts to encourage more consumer expenditure. Domestic economic woes and a reduction in imports will most directly cause a decline in commodity prices. As China’s economy slows, industrial energy consumption decreases, with fewer goods being produced as industries scale back operations, restricting demand for oil and gas.
As China is the largest consumer of steel and aluminum, decreased consumer spending on big-ticket items such as cars and housing will continue to place downward price pressure on these commodities. If China, a significant consumer of raw materials, reduces its imports, producers of these raw materials in other countries may adjust by scaling back their production. This can result in the reduced availability of these raw materials globally.
Fewer imports into China would also reduce the demand for freight, creating an imbalance in the shipping market. With excess capacity, shipping lines may raise freight rates to offset the lost revenue from reduced demand. Fewer imports may disrupt shipping schedules as carriers cancel sailing to balance supply and demand, leading to further volatility in freight rates and availability. Reduced imports will lead to a surplus of empty shipping containers that will need repositioning back to their origin, inflating costs for shipping companies which will likely pass on to buyers.
In light of these potential disruptions, procurement officials should establish contract terms that mitigate the impact of escalated freight rates and guarantee reliable scheduling and availability for shippers particularly exposed to such risks.
Why are Chinese exports declining?
While domestic troubles are primarily responsible for the decline in imports, the reduction in export volumes reflects shifting global trends beyond China’s influence. With the end of lockdowns, China anticipated strong global demand and increased production. However, surging inflation and rising interest rates globally, particularly in the United States and Europe, prompted consumers and businesses to tighten their belts in 2023. The slowing of the global economy has hampered Chinese exports significantly, having declined 14.5% year on year in July – the steepest decline since the initial outbreak of the coronavirus pandemic.
The drop is more significant when looking at the United States specifically, where Chinese exports declined 23.1%. This is in part explained by the practice of “friendshoring”, as the United States and other Western nations have reconfigured supply chains to become more secure and less dependent on perceived hostile nations – including China. The recently passed CHIPS and Science Act in 2022 is a direct result of this rebalancing strategy. Moreover, direct investment liabilities, which is a measure of foreign direct investment in China, fell to $4.9 billion from April to June in 2023 – down 87% from the same period last year, representing the lowest amount in any quarter in 25 years.
What does this mean for procurement?
Less global demand for Chinese goods will significantly weigh on the prices of Chinese exports. To account for falling demand, China may consider devaluing the Yuan, which has already slipped roughly 5% since the beginning of the year, to boost global demand for products, which would further lower the prices of Chinese exports to international consumers.
In procurement, you may gain greater bargaining power in negotiating contracts with Chinese suppliers, as these companies will be eager to retain or gain business. Such a strategy would be particularly advantageous to buyers with larger contracts and order volumes.
At the same time, a struggling Chinese economy could lead to increased lead times and supplier defaults. You must ensure your supply chains are resilient to such shocks by proactively sourcing alternative suppliers and planning contingency stock planning to avoid disruptions.
Your department should adopt a comprehensive perspective that encompasses all layers of your supply chain, taking into account not only Tier 1 suppliers but also the integral role and potential vulnerabilities of Tier 2 and Tier 3 suppliers.
Continued monitoring of the economic situation in China and its impact on global pricing and supply chains will be key for making strategic procurement decisions in the future.
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