By Julian Mayo
The old adage of being unable to plan a journey without knowing where you’re starting from is an accurate depiction of the problems in analysing the Chinese economy. Is it really expanding at an annual rate of 7-8%, as official statistics suggest? Or is the growth rate closer to 4%, as implied by looking at bank loans, electricity production and rail freight volumes (the three measures Premier Li Kequiang considers significant)?
The reality, in all likelihood, sits somewhere in between. Leading indicators such as the manufacturers’ Purchasing Manager Index (PMI) suggest a slowdown, while the service sector PMI remains buoyant. The former tells you where the economy has come from, while the latter is a better guide to what will drive China forward as its economy moves from being one driven by quantity to one driven by quality.
From the late 1960s into the 1970s, Japan’s economy progressed from a 9-10% growth rate to one closer to 5%. The same occurred in Korea 20 years later. In each case, growth which had been driven primarily by increased inputs was replaced by improvements in productivity and an expansion of the service sector. China is likely to follow a similar path. Policy-makers realise that they cannot simply build more roads and houses, make more steel, use more coal and maintain a growth rate of fixed asset investment twice that of nominal GDP. The service sector is already now the driver of the economy, being its largest and fastest-growing component. The internet is one example: Alibaba, the nation’s leading e-tailer, recorded sales of £5bn in a single day last November.
One beneficial implication of this transition to a service-driven economy is that China’s commodity intensity is passing its peak. Comparing again with Japan and Korea, China’s level of GDP per capita is consistent with an economy which will in future use fewer commodity inputs (such as steel, copper and oil) for a given unit of output. These will mean less pressure on commodity markets – and on the environment, which is an increasing focus of policy makers’ attention.
The property market was boosted in line with other hard assets following the stimulation measures enacted from 2009. The sector continues to attract widespread attention. It has been a curious boom, based more on supply than on prices, which have actually increased at a lower rate than nominal GDP in the last five years. Moreover, unlike the Western economies prior to 2007, property buyers have not taken on large mortgages or high levels of overall consumer debt. Likewise, the financial system is opaque, but the peak in the expansion of non-bank financing has passed, while the ratio of loans to deposits in the banking system are only 70%, a very low figure by international standards, while China’s huge internal resources mean that stresses in the banking sector can be resolved domestically.
The recent fall in oil prices is a boon to China. Monetary policy has been eased recently, with a reduction in the lending rate in November and a surprise cut in banks’ reserve requirement ratio earlier this year. The ongoing anti-corruption drive, which seems very popular in the country as a whole, has resulted in slowing consumption but there are signs that this cycle may be turning.
Our broad conclusion is that China is a more ‘normal’ economy than is often assumed. From a stock market perspective, while it is presently dominated by large state owned companies in resources, banking and telecoms, the better investment opportunities in our view are found in well-managed companies in areas such as retail, education, fuel distribution and in the rapidly-growing internet sector.
Julian Mayo is co-CIO at Charlemagne Capital (UK)
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