China’s import collapse: Is it import-substitution?

HONG KONG - The big puzzle of the Chinese economy is not exports’ under-performance but rather the collapse of imports, which saw their third consecutive month of double-digit contraction in October, says global asset manager, Nataxis.

External demand is weak, and China is losing competitiveness through high wage costs and an expensive exchange rate, Nataxis says. “Even if the RMB devalued slightly versus the US$, it still appreciated massively against China’s major trading partners, given that most other currencies depreciated more than the RMB.

“Furthermore, although China’s inflation remains low, it is higher than that of other major trading partners, especially Europe, adding to the loss of competitiveness.”

But despite having a very expensive currency, especially in REER terms, which makes imports cheaper, they continue to plummet well beyond exports, helping China trade balance balloon, Nataxis says. “It is now more than double what it was only a year ago - widening to US$489 billion from January to October versus US$233 billion for the same period of 2014.
 
Is growth plummeting as much as imports seem to suggest? We do not think so. The October Caixin Services PMI, a non-Government indicator, was rather solid, rising to 52.0 from 50.5 in September.

“This means that services remain resilient in China and the rest of the industrial sector, according to the Caixin manufacturing PMI, is not as bad as before. Since services already account for half of GDP and most of the growth, the double-digit reduction in imports cannot possible mirror this reality.

“If China imports are not entirely demonstrative of domestic demand, then what is driving their collapse? Waning appetite for capital to flow into China is one explanation.”

Nataxis says exports from Hong Kong to China are a well-known proxy of unrecorded capital flows into China, and that, due to “dampened enthusiasm” for “grey” capital flows into China, exports from Hong Kong to China have declined, “surely contributing to some of the collapse of imports”.

“The other potential reason is import substitution. Chinese authorities seem to be encouraging the utilisation of China-made goods versus imports. Imports have become so much cheaper that China’s official growth rate can’t possibly justify such a fall at even cheaper prices.

“In summary, slowing domestic demand only partly explains the import collapse puzzle. The other key culprits are dampened “imports” from Hong Kong and potentially import-substitution policies.

“While the latter is boosting a huge trade surplus and subsequently the current account, it has much darker medium-term implications. The Latin America experience shows that import-substitution policy is only a quick-term fix that ultimately quickens a country’s decline in export competitiveness.” www.nataxis.com (ATI).