CHINESE EXPORTS COULD CRUSH FRAGILE MARKETS / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( RECOMMENDED READING )

Chinese exports could crush fragile markets

By Ben Simpfendorfer

Published: June 29 2009 12:51

Talk of a “G2” is fashionable, and with good reason. The trip by Tim Geithner, US Treasury secretary, to Beijing last month underscored the substantial economic and financial interests at stake in the US-China relationship. His trip also signalled growing co-ordination between the two sides. The US avoided criticising an undervalued renminbi, while China committed itself to the dollar and its massive holdings of US government debt.

This change in focus is reflected at an institutional level in China. There is a growing body of research, for example, published by academic and official institutions, looking at China’s purchases of US government debt and the implications of the Federal Reserve’s quantitative easing. There is also anecdotal evidence that the same institutions are focusing more attention on G2-related issues at the expense of other countries.

The change makes sense, as the economic crisis has provided China with an opportunity to assert its economic influence. The push to test renminbi trade settlement, for example, is partly driven by pragmatic interests in reducing exporters’ currency exposure and transaction costs. But it also resonates with an official desire that the currency’s importance to the global economy will grow in line with China’s own economic power.

This shift in attention towards G2 may not last long. There is an equally important, but less well-observed, change taking place. It is a change that will strain China’s foreign relations with the emerging markets and make the argument for a stronger renminbi even more compelling.

China’s exports to emerging economies have surged. The value of shipments to Africa, Latin America, and the Middle East has risen from $38bn to $192bn (€137bn, £116bn) in the past five years. In fact, China recently overtook the US as the world’s largest exporter to the Middle East.

Indeed, it is increasingly common for Chinese exporters to distinguish between their traditional markets of Europe and the US on the one hand, and China’s domestic market and the emerging markets on the other. So, even as the world looks to China’s market as a potential saviour from today’s economic crisis, Chinese exporters are turning to the emerging markets in the same fashion.

It is not hard to find hard evidence on the ground of the change. I recently spoke to the Beijing Furniture Manufacturers Association, whose female president donned a black abaya to visit Saudi Arabia in March. She was taking part in just one of many Chinese trade missions to the Middle East. Chinese porcelain sellers in Dubai, meanwhile, talk of importing less blue porcelain, popular with European buyers, and more red, among which is preferred by Arab buyers.

The decision by Chinese exporters to look to the emerging markets in part reflects economic problems at home. Export manufacturers face intensifying domestic competition. The local media frequently quote factory owners as saying that it is easier to sell goods in other emerging economies than it is at home. So, the rise in China’s exports to countries such as Brazil and Egypt underscores the challenges faced by domestic manufacturing – in particular, overcapacity and thin profit margins.

The policy response to these economic challenges has only accelerated the rise in exports.

The recent hikes in export rebates of value added tax, for example, have typically targeted the type of low-cost goods, such as textiles and furniture, that are popular in the cost-conscious emerging markets. So, whereas VAT export rebates once spurred exports to Europe and the US, especially during the last global downturn in 2001, they are now spurring exports to emerging economies.

However, what is good news for China is not always good news for the rest of the world, as the surge in exports has meant factory closures in emerging economies.

The Federation of Indian Chambers of Commerce and Industry recently noted that two-thirds of small and medium-sized enterprises are suffering from the sudden rise in imports of Chinese capital and consumer goods. Syria’s government imposed tariffs on Chinese textile imports in response to rising factory closures in Aleppo, the country’s historic centre for textile production.

China’s focus on the G2 is important. But its focus on the emerging economies may soon steal the spotlight.

The argument for a stronger renminbi is even more compelling as a result of these changes. Chinese low-cost producers compete more directly with producers in emerging economies, increasing the risks of factory closures and job losses. Moreover, many governments in the emerging markets do not have sufficient fiscal resources to pay unemployment benefits or to fund economic reform.

Watch for China to increase its capital flows to the emerging markets to placate critics. Aid flows are already rising. Private direct investment may follow, especially as a way to circumvent trade protectionist measures. Rebalancing at home will also raise the cost of domestic production and spur more investment abroad, not just in Asia, but further afield.

The G2 is a symbol of China’s rise as an economic power. However, the country’s relations with the emerging world will be more instructive in how it intends to wield that power.

The writer is chief China economist for The Royal Bank of Scotland and author of The New Silk Road

Copyright The Financial Times Limited 2009