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We're all invested in china

Don't write off China just yet
December 21, 2012

The Chinese economy is slowing, that's beyond doubt. How the new leadership responds will dictate global investment returns for the next decade. The Chinese Communist Party has just smoothly completed its once-in-10-years transfer of power behind a cloak of secrecy. But while the outgoing Hu Jintao regime granted the incoming Xi Jinping unprecedented powers, it also bequeathed him major economic and social challenges.

We are all invested in China. Economists at Citigroup estimate that China's GDP contributed 45 per cent of global growth in the four years after the 2008 credit crunch, and Chinese annual consumption of many basic commodities is around half of the world total. During the decade of Hu Jintao's presidency, China's real GDP per capita rose at 9.9 per cent a year. Citigroup expects it to be closer to 7 per cent over the next decade. Those of the hard landing persuasion are convinced China's inherent problems will see growth dip below even that.

Chinese strengths

But those who write China off do so at their peril. The country's debt levels are a fraction of those in the US and the eurozone, which allows for plenty of fresh stimulus if required. And despite rapid development on China's eastern seaboard, there is still huge scope for infrastructure spending in central China.

Disposable incomes are still growing at double digits despite a slowdown in GDP growth. As incomes grow the Chinese service sector is rapidly filling the gap left by manufacturing and agriculture. The service sector now employs the most people in China and is forecast to grow strongly.

Under Xi Jinping, China is uniquely placed to tackle its problems head on. The Politburo standing committee that will rule China for the next five years has been reduced from nine to seven in an effort to ease decision making. Xi Jinping will also assume the position of Chairman of the Central Military Commission, centralising his power immediately. His speech to the 18th party conference was also noticeably free from references to Marxism, Maoism and Chinese communism, and outlined guiding principles of reducing income inequality, improving social welfare and market liberalisation.

In China the road to reform is open but change will be slow in coming. China's grand old men refuse to go quietly. The hand of previous leaders Jiang Zemin and Hu Jintao was clear in the Byzantine fashion in which the new politburo was chosen. The politburo is now split between leadership under Xi Jinping and Li Keqiang who owe their careers to Hu Jintao and the other five members who are all loyal to Jiang Zemin. The two biggest voices for political reform, Li Yuanchao and Wang Yang, did not make it onto the politburo.

China's hard landing has been avoided. The manufacturing sector grew at its fastest pace in seven months in November, and the smooth transition of power lays the foundations for an era of sustainable, albeit slower growth. But concerns remain over the anaemic pace of market and political reform. The inside money has voted with its feet, the Shanghai composite index is now at a four-year low, below the psychologically important 2000 level and IPOs have fallen to levels last seen in 2008. The global economy looks set to benefit from Chinese growth, but for those investing directly it looks like the slow boat to China returns.

Chinese weaknesses

China is over-reliant on fixed capital investment. The Hu administration's response to the 2008 crisis kept growth levels elevated and the economic miracle on track. It did this by filling the gap left by falling exports and comparatively low domestic consumption with increased fixed investment. Fixed investment is now about 50 per cent of GDP, while domestic consumption is just 35 per cent.

But fixed investment is not the only problem. China may have pulled 600m people out of poverty over the past three decades, but it has also created huge inequality. The Chinese people are willing to forego freedom of political expression in return for improving living standards, but if that growth slows or is seen as unfair the implicit social pact will collapse.

For China to rebalance it needs to go shopping. Saving rates remain high, and they have continued to rise up to 31.7 per cent, compared with 3.9 per cent in the US. To bring this down and get people spending, China needs to reform healthcare, education and pension provision. It needs to do this against the backdrop of an ageing population, which while not an immediate problem will increasingly be a drag on growth.

 

Major investment announced since May 2012

LocationTypeChinese Yuen
City of TianjinEastern CoastIndustrial to 20151.5trn
City of ChongqingCentral southernIndustrial to 20151.5trn 
City of GuangdongSouthern coastMarine industry1trn
Hunan ProvinceCentral southernInfrastructure829bn
Zhejiang ProvinceEastern coastConstruction1.18trn
Guizhou ProvinceCentral southernTentative invesment plan3trn
28 citiesAcross Chinasubways1 trn
Total10trn
Post Lehman package 4trn

Source: Credit Agricole Note: spending is spread over a longer period than Lehman package