China is back, bringing profit and perplexity to western business – 04/24/2023 – Market

Xi Jinping’s China is on the mend and looking to do business with Western companies. While breathing new life into the bottom lines of multinationals, this effort is also creating a new dilemma: whether or not to invest in the world’s second-largest economy as geopolitical tensions over Taiwan’s fate intensify?

Since Beijing lifted all Covid-19 restrictions in December, pent-up demand in the retail sector has fueled a faster-than-expected recovery. China’s economic expansion of 4.5% in the first quarter took a toll on Western brands’ revenue, especially at the higher end of the consumer spectrum.

Take Porsche, which reported a record 18% sales jump, driven by China, the biggest market for German luxury cars. Or LVMH, similarly buoyed by momentum in the world’s biggest luxury goods market, which the French group said generated a 17% rise in first-quarter sales, the exact moment when US growth faltered. Meanwhile, Hermès, another Paris-based rival, hailed “a very good Chinese New Year” with growth of 23% in its Asian revenues. In these upper echelons, consumers can pay up to 30% more for luxury goods in China than in Europe, according to bank Morgan Stanley.

But there is an “elephant in the room”, as Erik Nielsen, an economist at UniCredit noted in a briefing after the International Monetary Fund (IMF) meeting in the second quarter: Rising geopolitical tensions between China and the West are bringing “the most generational depth in economic policy thinking, and public policy priorities”.

In the United States, he wrote, “it’s all about containing China.” In Europe, this also happens, albeit in a milder version. This means that if (or when?) US-China relations deteriorate further in this tug of war, leading to more protectionist measures, including export bans and sanctions, “European companies will very likely be caught between the two sides. “.

Sven Behrendt, a partner at Berlin Global Advisors, said the business world was in a strange moment “where post-pandemic hedonism meets geopolitical risk”.

Businesses have become aware of this risk since former US President Donald Trump imposed a series of economic sanctions on Chinese companies, adopting a more confrontational policy towards Beijing, which continued under his Democratic successor Joe Biden. For supply chains, this stance, coupled with massive trade disruptions during the Covid pandemic, has led companies to abandon the notion of “just in time” and embrace “just in case” – from Intel to Apple, companies are reviewing their dependence on China and trying to transfer parts of their production to other countries, such as India and Vietnam.

But the interdependence with China built in the last two decades is such that this is not an easy task, as demonstrated by Apple’s difficulties in India. And if there’s a lesson to be learned from the much lesser decoupling between Russia and the West after the invasion of Ukraine, it’s that the process is painful for Western brands, and they are only grudgingly embracing it.

China’s economic recovery will only make these plans to diversify supply chains more difficult, especially for publicly traded companies. With increasing shareholder pressure, and the payout of incentives tied to stock price performance, the temptation to downplay geopolitical risks or ignore them will be greater (a US general recently predicted that Washington and Beijing would likely go to war over cause of Taiwan in 2025).

One proof is the German automaker Volkswagen, which owns Porsche, which this week announced a plan to invest one billion euros in building an innovation center in China. This comes after a decision last year to invest 2.4 billion euros in a venture with Chinese chip designer Horizon Robotics. Not exactly a sign of prudence for a country that a growing number of political officials regard as the greatest threat to the West.

Translated by Paulo Migliacci