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China in 2020: Lower profits, more bankruptcies, and new challenges doing business

China in 2020: Lower profits, more bankruptcies, and new challenges doing business
by Gordon Orr on 01-15-2020 at 6:00 am

China in 2020 Lower profits more bankruptcies and new challenges doing business

This is the fifth and final part of the series

For many industrial businesses, 2019 has been tough. Profits lower across the board – light and heavy industry, state-owned and private businesses. Labor costs rising while ex-factory prices are not. Access to debt restricted. The gap between high performers and laggards widened further, with leaders raising capital expenditures 20 percent plus over last year as they double down on deploying robotics, IoT, blockchain, and other productivity enablers in their supply chain. Laggards are edging closer to bankruptcy.

There are strong signs that we will see more bankruptcies in 2020. More banks will be allowed to fail beyond the four shuttered so far in 2019. The PBOC declared in its 2019 Financial Stability Report that it had closed 1000 P2P lenders in 2019 and that they evaluate close to 600 smaller banks (13 percent of the total) as “risky”. Their solution will have “Chinese characteristics”: failing banks will almost all be bailed out through merging with one of China’s larger banks.

More property companies will find they are financially extended beyond the level at which black-market lenders will support them. Industry consolidation will be the main solution. Investors will see more dramatic falls in share prices for specific stressed listed companies in the mainland and Hong Kong, along the lines of the 90 percent plus falls at Kasen, ArtGo and Tibet Water in recent weeks. This is a positive, companies that had been clogging up their sectors are finally being cleared out. Business will need to be alert to the financial state of their customers and suppliers.

High growth sectors in 2020 will be clustered in consumer facing services, many internet-enabled. Healthcare, education, travel, and leisure will all remain strong. Sectors where the Chinese government actively encourages investment have been clearly laid out– from semiconductor, to AI and smart cities, to manufacturing IoT, to biotech and advanced materials. Making money in these sectors directly in the short term may be tough, but making money out of supplying to these sectors can be very attractive.

Hong Kong and business

Hong Kong entered a recession driven by the downturn in tourists (nearly 1 million fewer travelers through Hong Kong airport last month with 20 percent fewer arrivals from mainland China) and by locals pulling back on spending. More than 50 conferences and exhibitions have been postponed or moved elsewhere. Popular hotels and restaurants have utilization down below 40 percent, even with 40-60 percent discounts, and are putting staff on unpaid leave. Retailers from clothing to jewelry have sales down as much as 50 percent from last year.

Businesses clustered in industries in and around the financial markets have been less impacted. Financial markets have not closed and IPOs are still happening. But changes are being considered. While they won’t make overnight changes to a successful operating model, many are now starting to think through the what ifs and could act on them in 2020.

For some multinationals, asking the basic question of why a large regional headquarters is in Hong Kong and why it is of the scale that it is can return slightly uncomfortable answers. For a good number, the answer is little more than it has always been like that – a location decision that was made rationally 20 or 30 years ago had not been challenged since then. Plus their senior executives like the low tax rates on offer in Hong Kong.

For China focused businesses, more regional activity could be undertaken in the mainland, without material additional cost. Asean and North Asian businesses may have grown to the scale to justify their own regional hubs. With mainland visitor numbers to Hong Kong looking unlikely to recover soon, luxury brand businesses are questioning just how many outlets they should retain in Hong Kong.

If clients from the mainland now prefer to meet in Shenzhen, it is straightforward to upgrade a Shenzhen office, to accommodate more permanent staff. Shenzhen or other local governments may even offer GBA policy incentives to do so.

Looking forward into 2020, business leaders in Hong Kong face tough organizational challenges such as sustaining a culture in which mainland and local staff work effectively, and persuading Hong Kong staff to continue to take opportunities in the mainland.

Few corporate leaders in Hong Kong are well prepared for these fundamental people challenges. There will likely be public instances where they fall short in 2020.

Closing

2020 is the final year in China’s decade long challenge to double its GDP. The government will be able to declare success (potentially with a little support from statistical revisions). US tariffs will continue to have minor impact on Chinese growth. Domestic consumption and investment will remain the key economic drivers, and China will deploy targeted stimuli to maintain momentum.

Many businesses will find 2020 a challenging, stressful year in China – more bankruptcies, more regulation, more unpredictable risks to reputation, and more selective consumer consumption. Yet China will only grow in importance to the majority of global businesses – as a source of global demand, of innovation, of capital, and of newly emerged world class competition. In spite of external pressure to deglobalize, global businesses will evolve their supply chain, their operating model, and even their ownership structure if needed to remain relevant in China.


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