CHINA’S GROWTH PROSPECTS IN A HISTORICALLY IMPORTANT YEAR
Head of Fund Research and Portfolio Manager
This year marks the 70th anniversary of the founding of the People’s Republic of China as well as the 30th commemoration of the armed aggression against pro-democracy student protests at Tiananmen Square in Beijing. As this fascinating economy has transformed itself over the past few decades, let us take a look at where it has come from and what its economic prospects are for the foreseeable future.
Up to the 1970’s, China was viewed as operating a largely closed economy. However, during the early 1980’s, under Deng Xiaoping’s leadership, China started embarking on economic and market reforms, with a specific focus on opening the country up to largely regional foreign trade.
CHINA ANNUAL REAL ECONOMIC GROWTH(%)
Source: Tradingeconomics.com I National Bureau of Statistics of China
The 1990’s saw much speedier Chinese economic growth, which was halted to some extent during the late 1990’s as China could not escape the challenges of the Asian Financial Crisis that started in Thailand, and quickly spread to other emerging economies in the region.
Then in late 2001, China became a member of the World Trade Organisation (WTO) which put the country’s growth trajectory onto a structurally significant higher path. So much so, that during the mid-2ooo’s, China’s economy grew at a phenomenal pace of between 10% and 14% per annum, until the Great Financial Crisis (GFC) of 2008 brought it to a sudden halt.
UNSTABLE SOURCES OF GROWTH POST THE GFC
During the recovery phase post the GFC, the Chinese economy improved on the back of a mostly credit-driven, manufacturing-led, export-focused and infrastructure-over-investment strategy. However, this path was not sustainable because a country can build only so many airports, train stations, manufacturing facilities and ghost-cities (areas comprising fully built-up residential and commercial areas and infrastructure, but with very few inhabitants) in order to artificially boost growth. Fortunately, the decision-makers realised that going forward, quality, rather than pace of growth needed to take preference if they wanted to bring the Chinese economy back onto a path that was more balanced, healthier, inclusive and sustainable over the long term.
As a result of this crucial mid-course correction decision, the Chinese economy currently finds itself in the middle of a significant and major restructuring process, where the focus remains on moving away from being export and infrastructure-investment dependent, to be more focused on consumption to drive economic growth. For example, the contribution to growth from the service sector, which includes sectors like retail, wholesale & consumer services, approached 60% in recent quarters.
A MORE REALISTIC STANCE NOW
The latest annual Chinese economic growth rate was registered at 6.4% in Q1 2019. To put this into context, annual economic growth in China averaged 9.5% between 1989 and 2018, reaching an all-time high of about 15% in Q1 1993 and a record low of 3.8% in Q4 1990. So it does seem as if the current decision makers are indeed less concerned about the level of growth but more about the structure of the economy, and the sustainability of future growth. Why do we say this? If the magnitude of growth was the sole focus, and the economy has cooled down from historic average growth of about 9.5% per year to about 6.5% currently, then we would probably have seen much more aggressive stimulation than what has transpired up to now.
This, in our view, is a positive attribute because the authorities recognise that the long-term sustainability of the Chinese economy is largely dependent on how they manage the large and unhealthy debt overhang going forward.
IS DEBT REALLY SUCH A PROBLEM IN CHINA ?
Although slightly lower than at its peak, Chinese corporate debt as a percentage of the size of the economy, is currently above 150%. This is about double the similar US ratio, and also significantly higher than its developing peers in Asia.
In addition, household or consumer debt as a percentage of disposable or “take home” income, has skyrocketed to exceptionally unhealthy levels.
Stimulatory measures, thus far during the current slowdown phase of the Chinese economy, have been relatively muted. Yes, we have seen fiscal stimulation via increased bond issuances, a lower VAT rate and other important tax reductions, and monetary stimulation through higher availability of credit and easier access to credit for small and medium size enterprises in particular, and a marked reduction in the reserve ration requirements for banks, since late 2018, but this has been muted compared to the significant stimulation that China did during the GFC, as well as during the sharp economic slowdown of 2015/16.
At the G20 meeting in Japan at the end of June, both parties did agree to resume trade talks. If, however, we were to see a significant escalation of the trade war between the US and China, which would further hurt business confidence, negatively impact on supply chains and trade activity and lead to even less capital expenditure, then the Chinese authorities will probably have no choice but to stimulate more aggressively due to the specific nature of the economic and the social development commitments they made to the Chinese population for 2019. These include amongst others the following goals:
- Economic growth of 6% – 6.5%
- More than 11 million new urban jobs
- A reduction of over 10 million in the rural poor population
- A macro leverage (or debt) ratio that is basically stable, and effective prevention and control of financial and fiscal risks
- Personal income growth that is basically in step with economic growth
If carefully managed, the Chinese economy could possibly still reach its 6% growth target for 2019, but downside risks are building.
As the Premier of the State Council of China, Li Keqiang, noted during his closing remarks in his March 2019 speech during the Second Session of the 13th National People’s Congress of the People’s Republic of China:
In our view, China will probably indeed reach its dream of national rejuvenation. However, given the current synchronised global economic slowdown and the lingering trade war, this dream may take some time to reach full fruition.