China, poised to reclaim its title of a superior civilization, faces scrutiny from fund managers over structural imbalances, demographic challenges, geopolitical risks, and the leadership style of President Xi Jinping. Let’s delve into these concerns.
Firstly, China’s colossal savings rate, peaking at 52% in 2008 and holding high at 46% today, is a double-edged sword. While it indicates a propensity for financial prudence, it also reflects an undercurrent of underconsumption. The resulting overinvestment, particularly in real estate, which accounts for a significant portion of the economy, hints at potential unsustainability—a sentiment echoed since 2007 by then-Premier Wen Jiabao.
Fortunately, measures are underway to address the looming debt crisis. The role of local government financing vehicles (LGFVs) in fuelling infrastructure projects is being recalibrated. The central government has intervened to prevent defaults and reallocate debts to entities with higher creditworthiness. For instance, Tianjin’s LGFV has seen a notable decrease in the average coupon rate from 7% in June to 4% in September, suggesting proactive debt management
The real estate sector, once a pivotal growth engine, is exhibiting signs of reaching an inflection point. Notably, the CEO of HSBC, Mr. Quinn, suggests the sector may have hit rock bottom, forecasting a resurgence. Moreover, UBS reports a drastic 65% drop in new construction sites from the second half of 2020, with sales stabilizing at 50-60% of the 2020-2021 peak.
Cash concerns
Concerns about a financial crash loom, given the substantial debt and the uncovering of banking fraud. The government has tightened its grip on the financial sector, aiming to cleanse the system and avert a systemic crisis. The debt, largely domestic and denominated in renminbi, positions China as a ‘creditor country’, with key banks under state control.
In the corporate sphere, Beijing employs a traffic-light system for IPOs, favoring ‘green’ sectors like high-tech, renewable energy, and electric vehicles, while deeming ‘red’ sectors like entertainment as lower priority. This strategic orientation, coupled with a clampdown on loss-making startups, reflects a stringent regulatory stance, partly inspired by the Nasdaq crash of 2000-2002.
Foreign investments, however, have suffered, with a 34% year-on-year decline in September, the steepest since 2014. Nonetheless, the government attempts to counteract this through targeted purchases by state investment groups aligned with long-term strategic sectors.
Despite fears of government interference, opportunities for collaboration in digital payments, electric vehicles, and solar panels are too vital for multinationals to ignore, as the Chinese market remains critical to their interests.
Demographics
Demographically, China faces a declining workforce, with the United Nations projecting a 25% drop by 2050. However, this concern is moderated by projections from Goldman Sachs and others suggesting more manageable declines, thanks to a healthier population and potential pension reforms. UBS highlights the ‘hukou’ system reform, encouraging rural workers to migrate to cities, which could offset the declining workforce.
Productivity growth, revised down from 4.8% to 3% by Goldman Sachs, is seen as a key to overcoming the demographic headwind. China’s robust education sector, particularly in STEM fields, feeds into its core strategy of technological advancement, a fact underscored by its leading position in patent applications.
In terms of global trade, the valuation of the yuan remains a contentious issue. While Capital Economics foresees a persistent undervaluation benefiting exports, Goldman Sachs expects a narrowing gap.
China’s growth reactivation hinges on boosting consumption. The high savings rate among Chinese households stands in stark contrast to the lower rates in Belgium and the U.S., where private consumption is a significant growth driver. China must navigate the ‘Middle Income Trap’ towards ‘Becoming Rich’, requiring a shift towards a consumption-driven economy, wealth redistribution, and combating fraud—a vision encapsulated by Xi’s ‘common prosperity’ ethos.
Electric vehicles
Strategically, China’s focus on electric vehicle production and renewable energy is poised to counterbalance the declining impact of the real estate market. Moreover, the country leads in several critical technologies, from advanced materials to quantum communication.
Predicting when China will catch up to the U.S. economically remains speculative, with Goldman Sachs optimistic about 2035, while Capital Economics is less so. Regardless, the U.S. and China are set to vie for economic supremacy in the coming decades.
In conclusion, China aspires to a renaissance of its historical status as a global superpower. Xi’s ‘Chinese Dream’ envisions a return to its legacy of innovation and high-value exports, reminiscent of its days as a leader in paper, silk, and porcelain. This ambition is further affirmed by the IMF’s acknowledgment of China’s growing influence in global governance.
Jan Vergote is a former head of investment strategy at Belgian bank Belfius. After his retirement, he founded Investment Talks. He specialises in asset allocation and is one of Investment Officer’s knowledge experts. His original column in Dutch is available on InvestmentOfficer.be. This English version is a condensed summary.