AFTER A STRING of negative news, including lockdowns in major cities, the Evergrande real estate crisis and regulatory crackdowns on tech behemoths, the Chinese government decided to tear down most zero-Covid restrictions, providing a dose of good news to the global community.
The decision came when countries globally were struggling with moribund economic growth, while four-decade high inflation pushed central bankers to hike rates at a pace not seen in a long time. China played a key role in lifting the global economy after the 2008-09 subprime crisis and the global community expects a similar miracle from China yet again.
The Chinese reopening has wide ramifications for the world economy, especially global commodity markets and their ripple effects on India.
CHINA, A MIGHTY FORCE
China is a trading Goliath that accounts for 20% of global exports and a 19% share of the global economy. It commands less than 3% of world currency reserves and international payments but the size of the renminbi bloc, a group of countries that use the currency, has nearly doubled to 29% of global GDP from just 15% in 2000. In the same period, the size of dollar currency blocs has declined from 50% of global GDP to 34% today, according to a Morgan Stanley report.
China’s reopening was big news for global commodities as it consumes over 55% of steel, aluminium, copper and zinc. It is also the world’s second-largest oil consumer that gobbles 15% of global crude.
China got a sobriquet of ‘The World’s Factory’ as it accounts for 28.7% of global manufacturing output, much ahead of the next four ranked nations, including the U.S., Japan, Germany, and India, with 16.8%, 7.5%, 5.3% and 3.1% manufacturing output, respectively, in 2019, as per the United Nations Statistics division. China supplies 37% of global clothing and accessories, 53% of furniture, 65% of global footwear and 70% of travel goods and handbags as per MDS Transmodal, a global transport economics firm.
The country, therefore, has the potential to lift the global economy from slowdown purely on the strength of its large manufacturing and consumption base.
THE INDIA STORY
The reopening has wide ramifications not only for the global economy but for India as well, as the latter gets ready to take advantage of the Western world’s ‘China+1’ strategy. China is India’s second-largest trade partner. The two-way annual trade with China (excluding Hong Kong) stood at $115.42 billion in 2021-22, around 11.2% of India’s annual merchandise trade of $1.03 trillion. Exports to China stood at $21.25 billion, while imports were $94.17 billion. In the same period, import from Hong Kong was $19.1 billion, a 25.86% rise over the previous year and export at $10.98 billion, an 8.09% increase YoY.
What are the advantages to India due to the reopening of China?
The move has wide ramifications for India Inc. — both positive and negative. In Q3, Dixon Technologies, India’s largest electronic contract manufacturer, saw a quarter-on-quarter dip of 37.75% and 32.8% on revenues and profits, respectively. Speaking with Fortune India, Atul B Lall, managing director, Dixon Technologies says the dip in topline and bottomline is on account of slowdown in Western Economies. “Many of our orders from Western world got cancelled due to sluggishness in their economies,” he says.
Being India’s largest electronic manufacturer, Dixon is in direct competition with Chinese contract manufacturers. Lall refused to disclose the price differential between manufacturing of Chinese and Indian producers, but market sources inform Fortune India that China re-opening has posed a challenge to companies such as Dixon Technologies and Amber Enterprises as China’s manufacturing scale is many times bigger than Indian companies, which makes domestic manufacturing a bit costlier.
THE METALS INDUSTRY
The global situation in the metals and mining sector is quite similar to consumer electronics.
In 2022, global production of primary aluminium was 68 million tonnes, with China producing 40 million tonnes (59%). Another 30 million tonne of recycled aluminium was produced globally. India roughly produced and consumed 4 million tonnes of global aluminium.
China consumes over 55% of global aluminium. The Chinese reopening is good news for Indian aluminium exporters. In FY22, China imported around 0.5 million tonnes of aluminium from India. But due to Covid lockdown and sluggish real estate in China, Indian companies exported just 80,000 tonnes of aluminium during April-November 2022, an 80% drop YoY.
“With China opening, a big export opportunity is likely to come up for Indian companies that are struggling with declining margins on account of rising power and raw material cost,” says Sumit Jhunjhunwala, sector head, corporate ratings, ICRA Ltd. Indian aluminium producers export 30-40% of their production.
In FY23, aluminium prices dropped while cost of production rose due to higher coal prices, leading to profit margin squeeze in companies, including Vedanta, NALCO, and Hindalco. Since China is a major importer of alumina, a key input for aluminium manufacturing, Jhunjhunwala believes alumina prices will also move up in future. The China reopening has led to aluminium prices moving from $2,100 per tonne to $2,300 per tonne between November 2022 and February 2023. “Any demand side push that arises may give a fillip to aluminium prices,” Jhunjhunwala believes.
The impact is also seen in steel, where China at 1,000 million tonnes accounted for 55% of global steel production of 1,830 million tonnes. India produced 125 million tonnes, or 6.8%, of global steel. Over the last three months, the price of HR coil has moved up from $500 per tonne to $650 per tonne due to China reopening. “On the back of its mammoth capacity and consumption, China has the wherewithal to stimulate steel prices,” opines Ritabrata Ghosh, sector head, corporate rating, ICRA Ltd. China closed many steel mills on environmental concerns that created export opportunities for Indian steelmakers. Bimlendra Jha, managing director, Jindal Steel says his company is filling the void left by Chinese steel manufacturers. “Our delivery time is the shortest among global steel manufacturers and the shutdown of Chinese steel factories during Covid presented great opportunities for Indian steel companies,” he adds
IMPACT ON PHARMA
Another industry that got impacted was pharma. The $1.2 trillion global pharma market is made up of $1 trillion in patented drugs while generic medicines account for $200 billion. The U.S. is the world’s biggest pharma market offering $500 billion (45% of the overall market), while Europe and China roughly offer $200 billion and $100 billion, respectively.
The Indian domestic pharma market is just $25-30 billion. The country exports around $20 billion of generic drugs in which U.S. imports around $7 billion while China is at $300 to $400 million.
Domestic pharma production is heavily dependent on China for key materials such as sodium, potash, chlorine etc. India roughly imports $15 billion of active pharmaceutical ingredients (API), intermediates, and key starting materials (KSM) from China, which translates into three quarters of the country’s pharma industry requirement.
India imports 95% of PAP, the main ingredient for manufacturing paracetamol and roughly 100% of penicillin from China. Gland Pharma, Laurus Lab, Divi’s Laboratories, Glenmark Life Sciences and Supriya Life Sciences were hit the most due to China lockdown as these companies directly or indirectly procure 75-80% of their raw material from China.
When China went under lockdown and supply constraints ensued, prices of raw materials started moving up. While most raw materials saw prices rise 10-20%, near monopoly products such as fermented products saw a much higher price increase from Chinese suppliers.
Higher raw material prices pushed up medicine prices in the domestic pharma market by 2% annually. In the last 12 months prices have moved up by 6-7%, says Aditya Khemka, fund manager, InCred Healthcare Fund.
“Due to raw material price hike, at a portfolio level, InCred Healthcare PMS companies saw a decline in gross margins from 69% in FY21 to 67.3% in 9MFY23 and this decline in gross margins resulted in 290 basis points decline in EBITDA margins (from 20.6% to 17.7%) over the same period,” Khemka reveals. Industry experts believe that reopening of China has led to a minor correction in raw material prices in the spot market.
Correction in raw material prices would reflect better margins in FY24, says Khemka. “We expect gross margins at a portfolio level to improve to 68% in FY24 against 67.3% in FY23, whereas, we also expect EBITDA margins to improve to 19.5% in FY24 from 17.7% in FY23,” Khemka adds.
AUTO SECTOR
The other area where India works closely with China is automobiles. The global auto original equipment manufacturer (OEM) and auto component manufacturing industry is roughly $3 trillion and $1.3 trillion, respectively. In the global OEM market, Indian OEMs have a 3% share while China is 41%. Last year, total revenue of Indian auto OEM and Indian auto component manufacturers stood at $80 billion and $53 billion, respectively, while revenue of Chinese auto OEM and Chinese auto component manufacturers were $1,225 billion and $550 billion, respectively.
In FY22, India’s auto component industry had a trade surplus of $700 million and the country exported $19 billion of auto components. In the first half of FY23, India’s export and import is equally balanced at $10.1 billion. But with China, India’s trade balance is highly skewed in favour of the former as India imported $4 billion while exported mere $300 million worth of auto components.
Anuj Sethi, senior director, CRISIL Ratings, says India mainly imports engine-related components, electronics, and plastic components from China that accounts for around 30% of the total imported auto components into India. “The opening up of the Chinese supply base for automotive components will lead to an increase in imports into India, given buoyant domestic demand across vehicle segments, especially passenger vehicles and commercial vehicles,” says Sethi.
He opines that despite Chinese suppliers having better economies of scale compared with their Indian counterparts, higher import of auto components will not impact domestic manufacturers since these were already getting into India from other geographies.
WILL CHINA REPEAT ITS MAGIC?
Though China faces a real estate crisis after the Evergrande meltdown, the economy can digest such hiccups. The real estate crisis may force a consumption slowdown but since China is an export-oriented economy, a domestic slowdown would not affect the global economy in a big way.
Between 1997 and 2022, global steel consumption went up from 700 million tonnes to 1.8 billion tonnes annually. The 1.1 billion tonne per annum incremental consumption was largely supported by Chinese demand (77%).
China has repeated similar feats in most sectors and the pace of growth was recently described by the World Bank as “the fastest sustained expansion by a major economy in history.”
China’s superior economic performance has also steered a fine financial performance in the stock market. Emerging markets have outperformed developed markets since the MSCI EM Index inception in 1988 mainly mainly due to the turbocharged growth of China, which commands 33% of the MSCI Emerging Markets Index. China weight in MSCI topped at 43% in 2020, but lost 10% post pandemic.
Today the world needs China. If history is an indicator, a repetition of the Chinese magic seems inevitable.