Investing in China, and ascertaining its prospects is not straightforward – it is a nation full of contradictions: a country with a vast amount of rural poverty but the world's second-largest economy; ostensibly a communist dictatorship, but at the same time a capitalist powerhouse. It is now in the middle of an unprecedented transition, changing from the world's main low-cost manufacturer to a model more akin to a developed nation, where growth comes neither from exporting nor building but rather through domestic consumption.
China's economic health matters to all of us, in particular because the country was instrumental in keeping the global economy afloat after developed economies inflicted the financial crisis on the world. Its importance is increasing; imports of goods and services in China climbed to 27% of GDP in 2011 from 14% in 1991.
In the short-term we are confident the country can easily overcome any economic hurdles related to its massive building programme of recent years. This resilience should help underpin the US-led recovery and create opportunities elsewhere in the world, but we are wary of allocating much to China directly. The deliberate decision to move up the value chain and let its currency appreciate means that it no longer makes sense to categorise it as similar to countries like India or Thailand – there are better places to benefit from an increased demand for low-cost manufacturing as the global economy recovers. At the same time, a combination of factors means any worthwhile investments tend to be oversubscribed, and therefore overvalued.
A Deliberate Change
China is changing for the simple reason that its present course is unsustainable. If you have expanded at about 10% every year for the past two decades, have overtaken Japan as the world's second-largest economy and seen living standards increase immeasurably over that period (World Bank Data shows that GDP per capita increased from $363 in 1992 to $6,188 in 2012) you cannot remain forever the world's go-to low-cost manufacturer with a never-ending supply of low-paid unskilled workers. In this situation you can either manage the transition to becoming a more developed economy or you can let circumstances play out. The Chinese government is quite obviously choosing the former.
For evidence one need only look at the country's regular five-year plans, which list its goals over the next half decade. The last one in 2011 showed it was committed to its urbanisation project, with plans for millions of subsidised housing units. It set targets for domestic consumption (the government said earlier this year it would increase the minimum wage to 40% of average urban salaries by 2015) and focused on actively moving up the value chain in manufacturing by allocating more money to research and development. In the short term its commitment to this transition can be seen in how it has allowed the renminbi to appreciate against the dollar this year, even as most emerging market currencies slid amid concern over economic imbalances in India and Indonesia.
With the Chinese government determined to rein in its unsustainable rate of expansion, the World Bank recently reduced China's 2013 growth forecast to 7.5% from its April estimate of 8.3%, a figure that has only slid below 9% once in the past 10 years. From a long-term global perspective this is beneficial, as a more viable rate of growth, and an economy less based on a building boom and more dependent on middle-class consumption is a more realistic long-term economic model. So what sometimes may appear to be a hard landing is in fact a managed transition from a high-octane emerging-market economic model to a more sustainable developed market structure.
A Bubble the Chinese Can Afford
On-going concerns that China still could suffer the aforementioned hard landing are focused on its burgeoning property market and any associated bad loans. The raw statistics give substance to fears that the country is in the midst of a property bubble – new home prices in China's four main cities showed their highest rise in August since January 2011, climbing an astonishing 19% in Guangzhou.
One factor driving property investing has been the lack of any worthwhile alternatives for locals, who face limits on what they can invest outside of the country resulting from capital controls. This has artificially pushed up the price of local stocks, the only equities readily available to them. At the same time bank deposits, in line with the rest of the world, are paying scant interest.
There is no end to the property supply to soak up this demand. The larger building projects remain highly ambitious (or ludicrously optimistic, depending on your point of view), containing resplendent skyscrapers, luxury apartments, majestic offices and glitzy shopping malls. A good example is the plan for Tianjin by Goldin Group (pictured below), owned by Hong Kong Property magnate Pan Sutong. It even boasts its very own twin towers and already houses a polo club (a sport bankrolled by the nation's wealthy elite).
Is this excess a problem? Only if the country could not afford it. Unlike Ireland for example, where a considerably smaller real-estate bubble was funded by loans from overseas, China holds $3.5 trillion of foreign reserves after running a massive trade surplus in recent years. There is no doubt that China chose to let this bubble inflate in order to keep money whirring around its economy while the financial-crisis-induced downturn depressed demand in the wider world. There's clear evidence now that the boom, having served its purpose of keeping the global economy afloat, is being gradually wound down by the government (as can be seen in declining commodity prices).
So we should not be overly concerned about this bubble, nor the effect a crash would have in unleashing a wave of bad loans on the country's banking sector. China has shown in the past a willingness to nationalise bad debt when necessary. Quite simply, the difference between China and the Western nations who faced a spate of property-bubble-induced bad loans that led eventually to the financial crisis is the difference between having billions of dollars of savings and owing billions of dollars, the former giving you the ability to throw money at whatever you choose.
Changes Across Society
A smoggy haze envelops building sites on the outskirts of Beijing
Last winter's toxic smog in Beijing galvanised the authorities to ban the construction of new coal-fired power plants in areas around Beijing and Shanghai and instead develop the use of natural gas and nuclear power.
The Investment Case
This content was generated prior to Turcan Connell Asset Management Limited operating as Tcam.