Why MENA should welcome slower growth in China

By Simon Kitchen

Two decades of strong growth in China has been good for the MENA (Middle East and North Africa) region. Demand for energy has kept oil prices high, and high rates of saving in China have been as important as the U.S. Fed in keeping global borrowing costs low. Chinese factories have supplied MENA consumers with cheap household goods and, increasingly, affordable luxuries such as smartphones.

But China’s growth has been unbalanced. A cheap currency, slow wage growth and low interest rates supported an investment-led boom in China that created tens of millions of jobs (a precedent that Egypt could learn from today), bringing hundreds of millions out of poverty. Ultimately, though, China has over-invested, especially in the past 10 years, and fears of a sharp slowdown in the Chinese economy are rising. MENA is not immune from the hangover.

Capital outflows from China are draining liquidity from global financial markets, driving interest rates — and price volatility — higher. Commodity demand has faltered, first for hard commodities such as copper and iron ore, but now for oil and gas. Chinese factories are now dumping their output on global markets. SABIC’s 4Q2015 results showed a loss of SAR1.1 billion (c. USD 290 million) on their steel operations, and years of low global inflation now threaten to shift into deflation.

The world’s second-largest economy is now rebalancing. This will mean much slower growth, but 3% growth in China is not to be feared. A rebalanced economy growing at less than 5% is a far more realistic prospect than the Chinese authorities adding more and more stimulus in pursuit of totemic 7% growth.

The reason is the Chinese consumer. Years of strong investment growth mean that household consumption represents around 35% of Chinese GDP. That’s half the rate as in the US and, incidentally, Egypt. Rebalancing means that consumption, rather than investment, should be driving the Chinese economy in future. If Chinese consumption were to continue growing in the high single-digits, this would be positive for China and the global economy.

This shift towards a consumption-led economy is good for MENA in the long run. Not all commodities are alike: Oil and gas are consumption commodities, used up in the production of energy. Many petrochemicals are also consumption goods, though recycling is changing the growth outlook for these products.

Moreover, rebalancing in China is not just about increasing consumption. Half of China’s primary energy consumption comes from coal, but pollution is becoming a political issue in China. Rebalancing towards cleaner fuels will favour MENA gas exporters — Qatar, Oman, Iran and Algeria, and potentially Egypt and Israel — over time.

Meanwhile, China’s government is bolstering demand for exports by investing heavily overseas. MENA governments can benefit from this capital outflow as they look to finance infrastructure investment at home. Such investments were among the topics of discussion for President Xi Jinping’s team as they swung through the region last week. MENA governments should be aware, though, that China will be using Chinese workers and Chinese materials in Chinese projects — Chinese financing is about business, not charity.

However, MENA economies are not immune from global forces. Weaker Chinese demand for investment goods has been a blow to commodity exporters, such as Australia, as well as machinery exporters such as Germany. Weaker investment demand is hitting some of the world’s major economies, and this has a clear knock-on impact on MENA.

And the rebalancing of the Chinese economy is full of risks. Chinese companies, particularly in the public sector, are overleveraged. Chinese banks are already pricing in a deterioration in credit quality. And while Chinese foreign reserves are large, they are not infinite. The Chinese authorities must be considering further weakness in CNY to maintain competitiveness, representing potential hits to household income and to the balance sheets of companies that have borrowed in dollars.

The onus is therefore on MENA governments to rebalance their own economies at the same time that China’s is rebalancing. Such reforms can include removing the distortions created by subsidies: Qatar, Saudi Arabia and Oman are following the example set by the UAE in August 2015, though Egypt has lost momentum. Oil exporters must move downstream: Energy efficiency and the rise of renewables mean that exporting chemicals and refined products is better business than exporting raw energy.

More fundamentally, MENA governments are now facing a period in which capital is scarce and must be more effectively mobilised from within and outside the region. Authorities should develop local savings institutions, increase foreign ownership limits in local economies, revive project-financing structures, and tap sovereign bond markets directly. They should even consider hitherto-taboo policies — such as currency devaluation in diversified economies and permanent residency for expats — as ways of attracting and retaining financial and human capital.

Chinese rebalancing is essential for sustained growth in the Chinese and global economies. But it is not enough for MENA to watch as China shifts to a services economy — MENA should rebalance at the same time.

The author is Head of MENA Strategy at leading regional investment bank EFG Hermes.

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