April 2017, James Brown, Portfolio Manager
China is a unique economy, given both its scale and the fact that it is effectively centrally controlled by the Chinese Communist Party (CCP) and Central Standing Committee (CSC – led by President Xi Jinping). And while China has embraced a form of capitalism, commonly known as the ‘socialist market economy’, the CCP can exert enormous control if it wishes through its single party government. And this is what makes China so fascinating to watch.
2016 saw economic stabilisation in China
The combination of targeted government stimulus and strong domestic demand saw China’s economy stabilise through 2016, generating real GDP growth of 6.7 per cent for the year. Economic stability will remain a priority for the CCP until the 19th National Congress in November, when five of the seven positions on the CSC are likely to be changed.
However, China’s transition from its heavy industry-based economy to one focused on the consumer and services also continues apace. We expect it to make good progress this year, albeit with gradually slower growth rates over time.
This is notwithstanding President Trump’s highly publicised pledge to shake up the US-China bilateral trade relationship, noting that US workers and firms do benefit from exports to China. For example, in 2016 Boeing delivered more aircraft in China than in the US. In fact, the manufacturing share of total US employment peaked in 1952 at 26 per cent and has been declining ever since (it was just eight per cent in 2016), as services take centre stage driven by rising productivity1.
As China specialist, Andy Rothman writes: ‘Change—primarily from advances in automation, and from shifts in consumer spending preferences—has always led to labour market volatility. Some occupations expand and thrive, others fade away, and brand new occupations appear. But, technology, not trade, is the main driver of this trend.’2
China’s economic evolution is being driven by its focus on consumption and services
While China is still a Communist nation with a centrally-controlled economy, the Chinese people are also wildly capitalistic – and in some cases, are encouraged to be so. State-controlled companies dominate heavy industry and parts of the economy, yet private sector growth has been enormous, accounting for virtually all urban employment growth over the last 30 years.
Mass migration from rural areas to cities was partly in response to an impressive 2009 stimulus, which sought to address the global economic downturn by modernising China’s economy through heavy investment. Yet the current shift to consumption and services is largely driven by the country’s burgeoning middle class.
Unprecedented growth lifted 600 million Chinese out of poverty
In 2000, China contributed just over 10 per cent of world economic growth compared with nearly double that from the US. Fast forward 15 years and China’s contribution has grown to over 30 per cent, and the US has dropped to just over 10 per cent. Today, China is the second largest economy in the world and continues to grow at a rapid pace.
The global middle class consists of three billion people and collectively they spent $33 trillion in 20153, and the International Monetary Fund predicts 1.5 billion middle-class people will live in China and India alone by 20204. China’s rising population will, in part, be led by the reversal of its one-child policy – China now allows two children per family – and as such, Deloitte analysts predict the country’s education market will almost double from 1.6 trillion yuan in 2015 to 2.9 trillion yuan by 20205. Chinese authorities are even considering rewards and subsidies to encourage couples to have a second child6.
Such rapid growth raises questions over sustainability
Along with its extraordinary economic growth over the last two decades, China’s debt levels have grown rapidly, particularly in the corporate sector. There was also an equity boom and bust in 2015 and a housing boom in tier one cities (Beijing, Shanghai, Guangzhou and Shenzhen) in 2016. So yes, China does certainly face some challenges, but is it headed for the ‘hard landing’ economic collapse sceptics predict?
While China’s debt has grown significantly over the last decade driven by the growth imperative and economic stimulus, the largest element is domestically-held corporate debt. There is minimal foreign currency debt – very different to what has typically precipitated previous financial crises.
Over the last year, heavily leveraged corporates have raised significant amounts of capital to reduce their debt burdens, and China has begun a program of debt-for-equity swaps where businesses with excessive debt loads are recapitalised by having their debt converted to equity.
Household debt is also very low, and more than offset by significant assets including cash deposits. While debt in China may be high by emerging markets standards, it is still well below of the average of the G7 bloc of industrialised democracies (US, UK, Canada, France, Germany, Italy and Japan).
China is likely to account for about one-third of global economic growth in 2017
This represents a bigger share than from the US, Europe and Japan combined7 and looking forward, Morgan Stanley analysts expect China to achieve high income status by 20278.
Likewise, we expect emerging economies to continue their trend towards a greater share of the global economy and while China will have some challenges as it continues to evolve, we believe the unique set of rules by which its economy operates will support the transition of its economy to one driven by domestic consumption. As such, we are of the view that China needs to be viewed through a different lens for an evolution that continues to provide some fascinating investment opportunities.
This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.
1. A Rothman, Trump, trade and China, Sinology, Matthews Asia, 7 March 2017, viewed 14 March 2017
2. Rothman, Trump, trade and China, ibid.
3. H Kharas, Trend Summer 2016: How a growing middle class could save the world’s economy, Pew Trusts Magazine, 5 July 2016, viewed 14 March 2017
4. Kharas, ibid.
5. Z Soo, Three sectors to watch for growth opportunities in China, South China Morning Post, 20 February 2017, viewed 14 March 2017
6. Reuters and agencies, China may offer rewards for second child, The Sydney Morning Herald, 28 February 2017, viewed 14 March 2017
7. Rothman, What a boring year, loc.cit.
8. C Ahya, J Garner, Why we are bullish on China, On the Markets, Morgan Stanley Wealth Management, March 2017, viewed 14 March 2017