China has seen manufacturing activity and new export orders ramp up in recent months. But as the pandemic rages on across the globe, concerns remain over long-term demand and operating conditions, while evidence suggests that Covid-19 and trade tensions with the US have accelerated global companies’ efforts to diversify their supply chains away from the world’s factory. Felix Thompson looks at the major trade trends for China in the coming year.
China’s manufacturing sector has been steadily returning to pre-pandemic levels since the nadir experienced earlier in the year, with the pace of the recovery quickening in the past couple of months as demand at home and abroad picks back up.
In February, with partial or full lockdowns rolled out in provinces across China to quell the spread of Covid-19, the headline Caixin Purchasing Managers Index (PMI) – a composite indicator designed to provide a single-figure snapshot of operating conditions in the manufacturing economy – fell to its lowest ever level of 40.3.
Manufacturing activity has since ramped up, however, with the headline PMI registering above 50 – the threshold between expansion and contraction – for five months straight.
There are signs China’s recovery is revving up even further, with the PMI for August rising to 53.1, marking the first time it had passed 53 since 2011.
And while the headline PMI for September saw a slight fall to 53 exactly, the Caixin PMI report detailing the results notes it signals “a further solid improvement in the health of the sector”.
One major factor driving the recent optimism for China’s manufacturers was a notable rise in new business, the report for September says, with the sub-index of total new orders rising to its highest point in nearly 10 years.
This increase was driven in part by an uptick in demand in China, but was also helped by sharply rebounding overseas demand, says Wang Zhe, senior economist at Caixin Insight Group.
With lockdowns easing in key markets such as the US and the European Union, the gauge for new export orders in the September PMI climbed at its fastest pace in three years.
China’s official government PMI, which focuses more on large and state-owned firms, also noted in its report for August that exports were 8.5% higher than for the same month in 2019.
There are, however, concerns that producers in certain sectors are being left behind. Moreover, the looming threat posed by US-China trade tensions, as well as the potential for key foreign markets reimposing Covid-19 lockdown measures, could weigh on the recovery in China’s manufacturing sector.
While “overall manufacturing demand has improved, the industry has recovered unevenly”, says Zhao Qinghe, an official at the Chinese government’s National Bureau of Statistics. There have been weaknesses in demand for clothing and wood processing manufacturing in particular.
“In addition, the global epidemic has not yet been fully and effectively controlled, and there are still uncertain factors in China’s imports and exports,” he adds.
Demand for trade finance support has been on the rise across the Asia Pacific region since June, with proprietary data from HSBC showing a sharp uptick in demand for core trade products across the major markets of Hong Kong, China, Singapore and Malaysia.
But at the same time, while transaction volumes have reverted to 2019 levels, order sizes have not, suggesting that the current volatile economic picture continues to affect buying decisions.
Ajay Sharma, HSBC’s regional head of global trade and receivables finance for Asia Pacific, told GTR in September: “Transaction sizes are 10-15% lower, and my interpretation is that this stems from caution in terms of ordering, which means, at a certain level, volumes are slightly down on certain products and there’s an offset in terms of margins, but overall, the business has held up quite well.”
Meanwhile Matthias Schemuth, partner and head of finance, projects and restructuring, Asia at law firm DLA Piper, noted at the GTR Asia 2020 virtual event in September that companies’ liquidity positions in the Asia Pacific region continue to be strained.
Many are turning to one of China’s two official export credit agencies (ECAs) for support, including for receivables financing products, with Sinosure backing “a lot of transactions” in the telecoms, tech and auto sectors in particular, he said.
Fielding pressure from the US
While the US and China may have put their trade war on hold with the signing of a phase one trade deal in January, tensions between the two remain high, and analysts seriously doubt whether China will abide by the agreement’s import quotas.
As part of the phase one agreement, the US agreed to reduce tariffs on certain Chinese goods, and, in return, China pledged to purchase more US-made farm, energy and manufactured products.
Beijing also promised to address some of the Trump administration’s concerns about intellectual property practices.
But the Peterson Institute for International Economics (PIIE) notes that China is well behind on its commitments to expand purchases of certain US goods and services by a combined US$200bn over 2020 and 2021, compared to 2017 levels.
According to PIIE’s trade deal tracker, China has imported less than half of the goods it had pledged to bring in from the US by this point; China’s year-to-date total imports of covered products from the US were US$56.1bn through August, compared with a prorated target of US$115.1bn.
With the progress of the phase one deal under scrutiny, trade tensions between the pair are also rising in other areas.
The US has been working to limit the influence of Chinese companies globally, especially in sectors seen as vital to national security, with the Trump administration pressuring the UK to ban telecom companies from buying Huawei-made 5G equipment.
For its part, the US has imposed sanctions on Huawei, putting it on an export control list in May 2019 in an attempt at restricting the company’s access to US-made and designed semiconductors necessary for vital products, namely telecoms network equipment and smartphones.
Concerned that Huawei was circumnavigating these rules, the Department of Commerce announced fresh measures in May this year, effectively banning chip manufacturers in any country around the world from selling semiconductors to Huawei if US technology was involved in any part of the production process.
The Export-Import Bank of the United States (US Exim) has become an increasingly active player in the Trump administration’s plans for taking on China in high-technology sectors, including 5G.
As part of its seven-year reauthorisation in December 2019, US Exim was directed to set up a Program on China and Transformational Exports, in a bid to help US firms compete against Chinese counterparts in key technology areas, which also include quantum computing.
The bank has become an increasingly active voice in National Security Council discussions throughout the course of the year, having also hired David Trulio from the Department of Defense to lead the new China programme.
Speaking to GTR earlier this year, US Exim’s chief banking officer, Stephen Renna, said that the bank would work to provide financing and support to Huawei competitors, whether US or foreign.
Supply chain shifts gather pace
Buffeted by the US-China trade war, and now Covid-19, there is growing evidence that global companies are speeding up efforts to diversify their supply chains and reduce their reliance on China.
For years, firms have been weighing up whether to shift their supply chains away from China, in order to sidestep rising labour costs in the country.
The so-called ‘China plus one’ strategy some companies have adopted – wherein they maintain some of their operations in China, while moving certain parts of their supply chains abroad – has seen firms opening up factories in Southeast Asian nations, such as Vietnam, in recent years.
But according to a report from analytics advisory company Silk Road Associates (SRA) and law firm Baker McKenzie, released in August, the US-China trade war has forced an increasing number of firms to move at least part of their manufacturing operations elsewhere.
The report – which examined export market share across 350 product categories and 150 countries – states that the earlier part of the decade was relatively static in terms of production and share of exports.
However, there were “significant swings” from China towards other emerging markets last year, within many, although not all, sectors.
Speaking on a Barclays webinar in late June, SRA’s chief executive and founder Ben Simpfendorfer said that China lost more than 2% export market share in over 78 product categories from 2018 to 2019.
The consumer goods sector has been particularly susceptible to change, the SRA report notes, with China’s share of global exports dropping from 46% to 42% during that period.
Bangladesh, Mexico and Vietnam account for most of the gains in global market share among low-cost consumer goods exporters, the report adds.
In addition to the US-China trade war, Covid-19 is also expected to reshape global supply chains and move production out of China. In the short-term, governments have already taken steps to reduce their reliance on the country for key Covid-19 supplies, such as medical equipment.
While China only had a 5% share of world medical exports in 2019, a report released by the World Trade Organization in April shows it is the main producer and exporter of personal protective equipment (PPE).
That meant when demand for such goods soared in the wake of the Covid-19 pandemic, governments around the world were left scrambling to source from the country.
Around the world, countries have already started making plans for diversifying their supply chains more generally, not just for PPE, with Reuters reporting in May that the US was looking to create a US$25bn “reshoring fund” to entice manufacturers to move production back home. Japan also announced a US$2.2bn economic stimulus package for reshoring supply chains.
But Simpfendorfer doubts that factories will “simply relocate back to Europe or the US, or even South Korea or Japan”.
“Asia will remain the world’s manufacturing hub, and China will remain critical to global trade. And we will increasingly produce in China for China, and Southeast Asia for the world,” he says.
The SRA and Baker McKenzie report notes that while China may have lost low-cost manufacturing activities in recent years, the superpower has gained export market share in areas where it has a strategic focus, such as energy, mining and infrastructure equipment – in part fuelled by the Belt and Road Initiative.
Simpfendorfer also points out that China’s sizeable population remains a key market for multinational companies, and so many manufacturers from countries like the US or Japan, or those in the EU, would want to retain manufacturing there.
“GM [General Motors] sells more cars in China than in the US. We’ve heard similar stories from a German chemicals company, a Japanese electronics company, an American industrial goods company. China is their fastest growing market. So, if they plan to build a new factory it’s most likely to be in China,” he says.