Over the past few months, some observers have developed an increasingly bearish outlook on China’s economy. Weak performances on several short term economic indicators such as the Purchasing Manager’s Index (PMI), the recent share market rout and the depreciation of the RMB have led many to suspect China’s economy is heading for a hard landing.
The situation for outside observers is complex but these bearish views focus too much on short-term economic indicators and emotionally charged sentiment, overlooking the scale and strength of an increasingly consumer driven and services based economy and the Chinese government’s total commitment and impressive efforts to advance a structural shift in the country’s economy. As a result, most outsiders have an incomplete view of China’s growth potential and this may lead Australian companies to make the wrong longer-term strategic decisions.
China’s economy officially grew at 6.9 percent in 2015, basically in line with expectations set by the central government and most analysts with full consideration of the myriad of challenges in implementing their late 2103 Third Plenum reform package. China’s GDP growth rate is still among the fastest of the world’s major economies.
Challenges ahead but Chinese authorities committed to reform
The Chinese economy has reached a stage of development where further growth must be driven by improved productivity and efficiency gains, private consumption, services and technological innovation. For this transition to be successful, China will have to address several challenges concurrently, such as industrial overcapacity issues, high levels of debt in certain sectors, income inequality, regional development disparity, environmental pollution and outdated and inefficient business cultures.
Chinese authorities understand this. They show a strong sense of commitment to their reform program by tackling the biggest issues and avoiding the temptation to implement traditional stimulus measures while making it clear they will take appropriate measures to avoid a hard landing of China’s economy. Balancing these two approaches and simultaneously addressing the range of large scale political, economic and social issues will be very difficult in the medium term, but China has the necessary policy tools, industrial capabilities and skills to succeed.
Services and consumer products growing
The services and consumer products sector, dominated by the private sector is growing steadily above 8 percent along the east coast and central China with healthy PMI growth. This is very positive for upper middle class Chinese consumers – the critical driver for future growth not only for China but the region’s economies. Just look at how this is impacting Chinese investment in Australia across real estate, healthcare, leisure and tourism, and education. And this is only the start!
China’s investment-intensive, export-led growth model has run its course
It is true that real estate construction, heavy manufacturing, heavy polluting and low value manufacturing export industries lead by SOEs with overcapacity are doing it tough with overall growth below 6 percent and impacting central, west and northern regions. The Government (policy makers and shareholders) are driving industry consolidation through merger & restructuring, increasing private sector ownership, replacing senior leadership and demanding improved efficiency, compliance and governance. At the same time, companies in these sectors are expanding overseas in search for new demand for their products. In this respect, the “Belt and Road” Initiative will provide great opportunities for China’s former economic pillar industries to expand offshore and soak up this construction and power capacity.
China’s share markets: a volatile history
China’s share markets have a long history of extreme volatility. The recent rout is yet another painful and embarrassing chapter for Chinese retail investors and governing bodies who are acutely aware of the importance of resolving this critical piece of financial infrastructure.
While the share market is a barometer of underlying economic activity, given the size of total market capitalisation (relatively low compared to overall GDP) and composition of investors (largely private individual investors), we should be careful not to associate the share market and broader economy as closely as we would for mature markets like the USA.
China’s A-Share market decline should be considered alongside the depreciation of China’s RMB exchange rate against the US dollar. The downfall of the Shanghai Index at the start of 2016, is partially due to expectations of further RMB depreciation and partly due to the failed “circuit-breaker” mechanism which triggered sell-off fears. This experimental mechanism has now been removed as a policy response. In the meantime, the vast capital is trying to find a safe haven.
Will overseas investment stop?
Questions are asked whether the Chinese government will stop all capital and wealth from going overseas, but this is not the primary intention of the central government. In 2015 massive outbound direct investment flowed into Australia by private sector investors in new sectors such as healthcare, foods and agriculture, real estate and infrastructure – all approved by Chinese foreign exchange regulators. Last week’s announcement of the $5.4 billion investment by Haier into GE in the USA shows yet again the actual ambition and scale of outward Chinese investment.
However, there is much greater scrutiny over the quality of outward investment proposals by SOEs and certainly attempts by private Chinese individuals to move large sums of wealth offshore through structures designed to circumvent the laws of China.
Implications of the thirteenth five year plan
The thirteenth five year plan, approved late 2015, and announced in March this year will set out the key policy framework for China’s ongoing reform and development program 2016-2020 with emphasis on advanced technology, services, renewable clean energy and major reforms to the SOE, financial and capital markets sectors. This is really positive news, the easy choice would be to revert to older models which would only increase the probability of an economic hard landing.
For any government trying to maintain stability in increasingly volatile global and domestic markets there will always be rapid response policy tinkering and controlled experiments but, to date Chinese reforms have been well structured, rigorously implemented and successful for the greatest majority.
The mood is optimistic
The mood amongst the large number of senior Chinese business leaders at a recent Chinese New Year event in Sydney was cautiously optimistic – certainly not bearish given the scale and ambition of China’s rapidly growing private sector. For investors, there remains abundant commercial opportunities for Australian companies to participate and grow in China’s restructuring economy using the China-Australia free trade agreement as a key platform.
Gong Xi Fa Cai, Xin Nian Kuai Le!