How China’s summer of discontent will impact on the UK economy

Siôn Roerts
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Siôn Roberts is senior partner at European Food and Farming Partnerships (EFFP), a specialist agri-food business consultancy, working along the whole supply chain. The organisation combines farming knowledge with food industry expertise to address structural, commercial, operational and relationship issues across the industry, from an objective and independent standpoint. Here, he discusses global economics in the context of the outlook for the UK and its agriculture industry

It feels like nothing is ever simple in the financial markets. First we had the Greek financial crisis causing international investor concerns and dampening the performance of global stock markets. No sooner had that problem been dealt with, another one came along – one that is potentially much more serious – China.

The China effect

Investors perceived a problem in China and stock markets around the world tumbled – a 20% reduction seen overall in the UK albeit that half of that has now been recovered. But why is China so important and why does its economic performance have such a marked effect on us all?

To give some context, China’s economy has grown massively in the last 15 years such that it, and other emerging economies, now account for more than half of the world’s economic output. Post the 2008 recession in Western economies, there was a big stimulus package in China to try to ensure their economy didn’t go the same way. The stimulus worked and China’s economy continued to grow, something that has actually been very useful for our own economy too.

But their economic growth has, in recent years, often depended on massive infrastructure projects and this has led to increased demand for commodities. An example would be metal. In 2000, China consumed around 12% of the world’s metal. Today it consumes more than half, using more steel than the USA, Russia, India, Japan and Korea combined. So, China is big in economic terms and it is big in terms of its influence on commodity markets.

Unfortunately, China’s economy is now slowing down. China moved from a situation where its economy was export-led through the 1990s and into the early 2000s, to a situation where its economic growth became more investment-led. But the infrastructure boom is ending and the economy is suffering as a result.

What is likely to happen? Well, perceived wisdom is that there will be a hard landing but that it won’t be disastrous, as the Chinese government is trying to engineer the slowdown with other stimulus activity. Rather than the growth of more than 10% year-on-year that we have been used to from China, President Xi Jinping has spoken of a ‘new normal’ that will see growth of perhaps 6% each year instead.

This reduction sounds significant, and it certainly is, but some context is important. China’s economy is much larger than it was 15 years ago and so 6% of a larger economy is still pretty good. And China’s economy is evolving, moving towards being consumer-led, much like most western economies. This shift sees demand changing. Demand for metal may decrease, for example, but the International Monetary Fund (IMF) suggests that the demand for food, particularly dairy and beef, as well as high-grade metals, will increase. And don’t forget that a huge proportion of the world’s exported soybeans already go to China, so food commodities are already pretty important there.

Outlook for the UK

So the story of the summer of 2015 has been one of discontent, economically at least. Greece and then China have exerted pressures on the global economy. But what’s the outlook for the rest of 2015 and into 2016 for us here in the UK?

Broadly speaking, hopefully not too bad. As long as China doesn’t become an absolute basket case the UK economy should continue growing. Household incomes are up and consumer confidence is at the highest level for more than a decade, whilst mortgage rates remain low.

Trade is suffering because of the low level of growth in our largest trading partner, Europe. But with a massive stimulus programme agreed in the Eurozone, which has delivered a big boost to the economies of those countries, this situation may improve.

Inflation in the UK is generally expected to gently rebound around the turn of the year, but it

is likely to remain well anchored and so reasonably subdued for the next couple of years. Average earnings are up – slightly over 3% this year. Indeed, the ASDA income tracker, shown on graph II below, illustrates how discretionary household incomes in the UK were either flat or falling through 2010, 2011, 2012 and 2013, before starting to increase through 2014 – an increase that has been sustained into 2015 and looks set to continue. 

Graph 2

Commodity prices are also down. Oil prices had a small mid-year increase, but prices are now almost as low as they have been for some time, and this is expected to continue in the short to medium term. Looking closer at the food industry, agricultural commodities are also trading in a low price range across the globe, with plentiful supply of both cereals and dairy products suppressing market prices.

Of course, this is not making for happy farmers and we have seen high profile protests in recent months. But what we are seeing is market forces at work. The agricultural cycle typically sees prices rise, which draws in investment, resulting in increased production. Prices respond negatively and, eventually, production reduces as farmers pull out of the industry, before the cycle goes around again. Economic difficulties in China and political issues in Russia, which impact on global demand, only complicate this volatility. And things are made worse for the UK because of exchange rates – see graph I below. At the moment the pound is high against the Euro, making our agricultural exports less competitive and making agricultural and food imports more affordable. This sees things like cheap Irish Cheddar and pork and potatoes from the near continent rush into our market, making conditions increasingly difficult for UK farmers. 

Graph 1

Low prices and low income to prevail

So, low global commodity prices are a big driver of farm incomes in the UK and the general weakness in the market may start to feed through into land prices too. Eventually, the agricultural cycle will bring prices back up, but it appears likely that the longer term decline in real agricultural prices, seen over many years up until 2008, is back in place. However, the low prices we are seeing now are still higher than those seen pre-2008 as a result of tighter resource availability and higher costs.

Overall this means that food affordability is likely to continue to improve. This means that retail food prices are expected to remain low, and given the wider context of rising household incomes, this should start to result in volume growth – a positive for the food sector.

Inevitably, there are risks. The key one today is that China’s economy crashes. Europe remains politically and economically volatile, and asset bubbles remain – the stock market is still high overall and land prices are higher than can be justified by agricultural returns. Then there is the weather, and we are only ever one weather disaster away from another price spike in agricultural commodities, although with global stocks high, there is a degree of protection from this danger.

Restructuring ahead

What this all means, then, is that farm incomes are likely to remain low – the golden years of farming that we’ve experienced since 2008 are over, at least for now. This is likely to lead to major restructuring at farm level, as less competitive farms can only keep going for so long at low price levels.

Restructuring is also expected at retail level. Margins remain low for food retailers as they fight it out against the rise of the discounters and sufficient growth isn’t there and hasn’t been for a while. This is anticipated to lead to significant restructuring, although the exact shape that this might take is unclear at the present time.

But the outlook for the UK economy remains okay and the outlook for the food sector continues to brighten, albeit rather slowly.

As the traditional Chinese curse is written, “May you live in interesting times!” and it certainly seems to be true at present. If China’s economy really ‘sneezes’ then the rest of the world will ‘catch a cold’ but, if 6% does end up as the new norm, then perhaps that’s not too bad when it’s 6% of such a huge economy. We can never predict with certainty what will happen, but look through the noise of this summer and, despite the risk factors, things still look just about on track to improve.

Siôn’s perspective is in Reynolds’ August 2015 newsletter, the Marketplace.

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