What do China’s weak import numbers mean for its economy?

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For the month of March, China reported an unexpectedly large trade surplus , defying expectations that China's foreign trade composite was in a secular change towards enhanced consumption that would see its trade surpluses shrink.

[caption id="attachment_59097" align="alignright" width="300" caption="Xintiandi in Shanghai, China"] Image courtesy azureisle: http://www.flickr.com/people/aoshima/ [/caption]

Were these pundits mistaken, and is China back to re-emphasizing the Guangdong model, a neo-Mercantilist agenda of maintaining massive trade surpluses to the potential long-term detriment of the Chinese ( FXI , quote ) economy? Or was this merely a statistical outlier, a bump on the road towards a consumption-driven economy?

Recent data, forward-looking indicators, and statements from developed multinationals seem to indicate that the latter is the more likely scenario. Lower manufacturing imports, a stronger yuan, weak demand from Europe, strong April service-related data, and mixed April manufacturing data all point to a continuation of the trend away from an over-reliance on exports and a cautious move towards consumption and services.

Investors listening to the conference calls of certain manufacturing firms and multinational corporations were somewhat taken aback at the tone these companies employed when addressing the subject of China. In particular, earth moving equipment manufacturer Caterpillar ( CAT , quote ) made a point of downplaying the importance of China for its company.

"China is not a huge part of our business," said Mike DeWalt, Caterpillar's head of investor relations, claiming that the country represented only 3% of sales. (You could argue that the company's indirect exposure to China is much larger however). In fact, Caterpillar stated that they now see demand for construction equipment contracting this year, as opposed to initial forecasts of 5-10% growth for 2012.

This soft demand is not confined to Caterpillar. During their earnings announcement this week, Emerson Electric ( EMR , quote ) saw a steep, unexpected drop in Chinese demand indicating very poor Chinese manufacturing sector performance. German conglomerate Siemens ( SI , quote ) also saw China revenue drop 6% , compared to a 9% increase systemwide, although the company expects growth to pick up in the second half.

Import strength or weakness in the Chinese manufacturing sector can be interpreted as a leading indicator for the state of its export sector going forward. Capital Economics' analysts claim that March import weakness "impl(ies) that exporters have low expectations for future orders growth."

The most recent Purchasing Managers' Index data is mixed on the subject. According to the government, PMI came in at 53.3, indicating an expansion. However, HSBC's reading was 49.3, implying a contraction, although month-over-month growth.

Because of differing methodologies -- in general, the government's data tracks the bigger, state-owned firms whereas HSBC's numbers place more emphasis on small and medium-sized firms -- the government and HSBC manufacturing data frequently report a different picture of the state of the Chinese economy. As a result of these disparate methods, it's difficult to glean anything definitive.

While PMI may not afford investors any particularly compelling insight into the state of the Chinese export sector, fundamental macroeconomic analysis can yield important observations.

The Renminbi has appreciated against major developed currencies like the dollar and the euro over the past year, rendering Chinese exports less competitive. The euro zone remains China's largest trading partner, and with growth discernibly affected by the sovereign debt crisis in Europe, China will have to look elsewhere for export sector expansion.

While the American and South Korean economies remain relatively robust, other trading partners like Brazil, India, and Australia see growth slowing . This is by no means indicative of a precipitous decline in Chinese exporting prowess; however, export sector growth may be limited in the short-to-medium term in light of these macroeconomic constraints.

Although the export sector may be under structural stress, China may finally be making tangible, albeit incremental, progress towards a consumption-based economy.

HSBC's services PMI number for April was a formidable 54.1, a six-month high. Job hiring in the sector continues to grow and shows domestic demand may finally be stabilizing after months of previously soft demand. HSBC economists see the economy as a whole beginning to recover , claiming that "(t)he chance is slight for China to post lower growth in the second quarter, compared to 8.1% growth in first quarter."

The move to a consumption-based economy will not be smooth, in particular during a period of political transition . The percentage of government investment driving domestic demand remains uncomfortably high. The savings rate also needs to drop to more desirable levels. Previously-employed protectionist methods used to shield domestic manufacturers may be less feasible for intangible goods without backtracking on progress in the liberalization of certain rules and industries.

That being said, it appears as if China may be taking the initial steps necessary to transform its economy away from the Guangdong model to a more sustainable one geared towards consumption: the Xintiandi model , perhaps?



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , International , Stocks

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