As China's economy slows, pain hits home

If the slowdown continues, it would reduce demand and prices for a wide range of materials.

Piles of unsold coal line rural roads in north-central China. Some iron ore mines near Beijing are operating at a fraction of capacity. Chinese farm products are even increasingly scorned by the Chinese consumer.

While China remains nearly self-sufficient in all these categories, it is importing more from other emerging markets. Economists and investors around the world have been fretting in recent days about the effects on smaller emerging markets if China’s economic slowdown worsens. Those concerns have driven down share prices and currencies from Jakarta to Istanbul to Buenos Aires, although emerging markets staged a partial recovery Wednesday. They helped to prod the central banks of Turkey and India to raise benchmark interest rates unexpectedly Tuesday.

Yet the most vulnerable producers these days may not be the coal mines in Indonesia, palm oil plantations in Malaysia or soybean farms in Brazil, but the farms and particularly the mines in China itself. China’s role as the largest buyer of a long list of commodities, from iron ore to palm oil, means that emerging markets are heavily exposed to any economic slowdown. But their ability to capture ever-larger shares of the Chinese market at the expense of China’s commodity producers has limited at least somewhat the exposure of emerging markets.

China’s steadily strengthening renminbi, persistent inflation and soaring blue-collar wages have combined to erase much or all of the cost advantage of domestic production for a long list of commodities. At the same time, tightened pollution regulations have made it harder for steel mills to use China’s low-grade iron ore reserves or for power plants to burn China’s low-quality coal.

Counter impact

Another profound change in Chinese society is also having an impact. Hundreds of millions of Chinese are eating more meat and drinking more milk. The extra animal feed, as well as chicken, beef and dairy products, for that shift is coming increasingly from farms as distant as Uruguay and Argentina.

Chinese farms have grown uncompetitive because they tend to be small and inefficient and have a reputation for contaminated food. Charter rates for bulk freighters, often a good leading indicator of China’s commodity imports, have stayed strong. The shipping industry is betting that even when long-distance freight charges are included, new mines opening in Brazil and Australia will outcompete mines in China.

Emerging markets face many more pressures right now than the strength of China’s demand for commodities. A gradual tapering in the pace of monetary stimulus by the US Federal Reserve, where policymakers were concluding a two-day meeting Wednesday, has sent interest rates drifting higher in America, drawing in investment dollars that might have previously gone to Bangkok or Rio de Janeiro.

Rising exports to China by emerging markets also mean that if a downturn in China is severe enough, emerging market exporters will be affected along with Chinese producers. China could also adopt a variety of measures to keep out imports during a downturn, like providing government subsidies to domestic producers - although many of these possible steps would violate China’s commitments to the World Trade Organisation.

Many emerging markets, including India, have fought losing battles with inflation for years and are now struggling to maintain the value of their currencies. After announcing this month a two-year plan to slow inflation in consumer prices, the Reserve Bank of India announced Tuesday that it was pushing up its benchmark short-term interest rates by a quarter of a percentage point.

Raghuram G Rajan, the central bank’s governor, acted even though his country’s manufacturing sector, heavily dependent on borrowing and sensitive to any increase in rates, is already slowing. The Turkish central bank raised its benchmark interest rate a surprisingly steep 4.25 percentage points on Tuesday in an attempt to defend the nation’s currency.

If China’s economy slows further in the coming months, that would not just hurt demand and world prices for raw materials. It would also reduce demand and prices for a wide range of industrial materials, like steel, produced in many emerging markets.

An HSBC survey last week found considerable gloom among many Chinese manufacturers. Some wholesalers and retailers in China say that they also see signs of weakness in the crucial shopping period ahead of Lunar New Year celebrations beginning Friday.

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