Poor economic conditions make for a gloomy Chinese New Year

Poor economic conditions make for a gloomy Chinese New Year
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Chinese New Year 2019 begins on Tuesday, but economic conditions may put a damper on the jubilation. As the trade discussions between the United States and China enter a critical phase, it is becoming clear that China’s economy has taken a hit as a result of the ongoing trade tensions.

A recent article published in the Wall Street Journal described rising asset impairments and declining profits within China’s private-sector companies. 

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The article goes on to indicate that 395 companies listed on the Shanghai and Shenzhen stock exchanges have provided guidance that they expect to report net losses for 2018.

In addition, a record number of private Chinese companies are reporting asset impairments due to decline in goodwill. When a company purchases another company through merger and acquisition, the price paid above and beyond the book value of the acquired company’s assets is recorded as goodwill.

To use an example, if Company A purchased Company B for $200 million, and the total assets recorded on Company B’s balance sheet totaled $100 million dollars, the extra $100 million is recorded as goodwill on Company A’s balance sheet.

In a sense, goodwill represents the premium that is paid above and beyond the actual book value of an acquired company’s assets. 

In years prior, Chinese companies went on buying sprees, purchasing companies both inside and outside of China, enlarging their business scope and operations. Some of the acquired companies were within the same industry, while many acquisitions had nothing to do with the acquiring company’s core business.

What has become evident is that Chinese companies over-paid for acquisitions during good times, and over time, the high prices paid have had no relation to actual value of the assets.

As a result of the present downdraft in the overall Chinese economy, the values of many such acquisitions are going into free fall, leading to an increase in recorded asset impairments, as required by accounting guidelines.

This is an ominous sign that one of China’s most vibrant sectors is losing steam, and it's part of an overall picture that things are not as good as official proclamations suggest. It represents another piece of the puzzle that suggests that China’s once-robust growth is fading rather quickly.

Recently, China released the Purchasing Managers' Index (PMI) figure for January. It was recorded at 48.3, coming on the heels of a December 2018 PMI figure of 49.7. A figure below 50 signifies a decline in manufacturing activity. 

To right the ship, China’s policymakers have implemented a number of measures to rebalance the economy. As China’s export-economy slows, China has initiated steps to encourage consumers to increase their spending with the intention of boosting the economy.

Unfortunately, most such measures have not worked out as intended. Evidence indicates that Chinese consumers have tightened their belts and are acting with increased caution regarding large purchases, like automobiles and real estate. 

Apple’s most recent sales figures in China are a clear sign that Chinese consumer sentiment is in a state of retrenchment.

Caution among Chinese consumers is due to perceived risks regarding their own personal economic situation as well as with respect to the overall economy, as trade tensions continue unresolved.

As evidence mounts of a slowing economy in China, soon China will have some company. Nations that have been dependent on China’s growth engine are also signaling contraction.

Countries such as South Korea, Japan and Germany have benefited from China’s growth as these nations supply China with critical parts, advanced machinery and other inputs essential to China’s manufacturing economy. In a sense, as China catches a cold, other countries will not be immune from infection. 

Arthur Dong is a professor at Georgetown University's McDonough School of Business. He specializes in legal and business engagements between China and the United States.