Taming the dragon - the long-term outlook for China's economic growth
China has caused a lot of anxiety this year. Investors were shaken by the devaluation of the renminbi by the People’s Bank of China in August, which raised fears of a ‘hard landing’ for its economy and knock-on deflation for the rest of the world. Yet China is far from over as an investment theme.
By Edward Smith, Asset Allocation Strategist
This was confirmed by a recent trip to Shanghai. The private sector is rapidly emerging from the shadow of the state-owned enterprises (SOEs) to become the dominant force in China. The services sector, which covers many of these private companies, now accounts for half of GDP. Meanwhile, industrial China remains sluggish and debt-laden – it is a two-speed economy.
The SOEs appear to acknowledge the changes required. During my visit, I was heartened to hear state-owned giants discussing ‘free cashflow’ and ‘return on equity’. Yet I would be reluctant to conclude that ‘China Inc’ is suddenly shareholder-friendly, especially as the last two years have seen an increase in internet censorship and intense suppression of public debate.
China recently recommitted to doubling its economy by 2020, suggesting annual growth of 6.5% for the next five years. However, we believe the authorities could adjust how GDP is calculated, increasing the size of the economy and allowing the leadership to achieve its objective. Growth could remain around current levels, averaging 4.1% to 5.5% from now until 2025 – a reflection of a structural slowdown in the exceptional growth of the past decade and not overly worrying.
Rebasing GDP could also improve the accuracy of China’s economic data, most of which are biased toward the state-owned heavy industry of old China. The new services and technology companies that are much less capital-intensive are under-represented in the official figures. These companies are doing very well right now. During my trip, I saw middle-class consumer products selling for exorbitant sums – consumption appears to be very healthy.
The state-owned industrial giants might be lagging, but the buoyant privately-owned China of tomorrow is most certainly not.
We’ve heard a lot about China recently, so what is this report saying?
1. We ‘nowcast’ growth at 4% to 6% and believe that a hard landing is unlikely. The slowdown has largely happened and, while old China is suffering from overcapacity, the new consumer-driven economy is still performing well.
2. Very few commentators are looking at the long-term outlook for China. We believe that China will grow at an average of 5% per annum over the next 10 years, compared to 10% a year over the last decade – while this will support global growth in the longer term, we face an extended period of adjustment to this lower growth rate, which will affect heavier industries and many of the markets and companies that import to and export from China.
3. I have recently returned from a 10-day trip to China, visiting companies in the state-owned sector, companies that have partnerships with Western companies and companies in the new digital economy. This has given me a good insight into the diverging economy and some of the policy challenges that politicians will face.