Since China’s accession to the World Trade Organisation (WTO) a decade ago, its economic model has been a simple one: export-led growth supported by large amounts of fixed asset investment growth, particularly when export markets have not been supportive.
For a number of reasons this model no longer makes sense. Export markets are likely to remain subdued for some time: China’s share of world trade, although still growing, cannot continue to increase at such a strong rate, particularly when wage growth is reducing low-end competitiveness.
Fixed asset investment is also unsustainably high and the country is in danger of moving towards a situation where it ends up building roads to nowhere.
However, this is not the end of China’s growth story. We can be fairly sure that the days of growth remaining constantly above 8 per cent will soon be a thing of the past, but that does not mean that the country is going to descend into stagnation and anarchy.
I do not know what the sustainable rate of growth for China in the future is: nobody does. What I do know is that the most important building blocks for growth remain in place. These include:
A willingness to change
At both the government and individual level there is very little complacency. The Chinese government realises its only source of legitimacy arises from its ability to preside over a stable and growing economy.
It is desperate to reform the economy in order to survive itself and willing to ask for help from anywhere, as demonstrated by the recent partnership between the Ministry of Finance and the World Bank to examine China’s long-term challenges.
At the individual level, there is a tremendous hunger for betterment, encapsulated in the long working hours which hundreds of millions of Chinese are willing to endure. It is also reflected in the thirst for knowledge that can be seen every time you walk down a Beijing high street and get accosted by Chinese wishing to practise their English on you.
Cheapness and improving productivity
The world’s manufacturing base is not going to move from China. Nowhere else has the combination of cheapness, scale, infrastructure and stability which China represents.
The huge increase in Chinese patent lodging is evidence of increasing innovation. So too is the ability of companies such as ZTE, Lenovo and Huawei to come from nowhere and challenge established global brands.
Availability of capital
High savings rates and a solvent banking system are available to provide the capital for future investment. The Chinese banking system is deeply unsophisticated and is the economy’s Achilles heel. High double-digit capital ratios will give it the breathing time to reform even though bad debts from the last infrastructure binge will undoubtedly rise.
These are huge positives; however, the negatives are also troubling.
For example the lack of domestic base material resources and good quality agricultural land, which is leading China into areas where it has little knowledge and where the scope for mistakes is huge.
China’s lack of alternative investment vehicles has also led to an unhealthy storage of wealth in high-end properties in the major cities. Furthermore, its demographic profile is changing and its population is set to age over the next decade. Finally, corruption is endemic.
However, the balance of probabilities is that these issues will slow but not reverse the growth of the Chinese economy. For example, even now after a concerted effort to reduce property price appreciation, the thirst to get on the ladder is huge.
This is an interesting contrast with Japan after its bubble burst in the early 1990s. So too is the continued greater-than 20 per cent growth in tax take; the best evidence that Chinese growth is real and the government still has the ability to control.
As to the political situation, the demise of Bo Xilai is probably a good thing. Commentators have said that this is probably the most important political event in China since Tiananmen Square. That is probably correct. But it says more about the country’s political stability over the last 20 years than anything else.
The thirst for western-style democracy in China can be exaggerated. The reverence for such undemocratic figures as chairman Mao and Deng Xiaoping does not sit comfortably with a desire for full-scale western democracy.
What is needed (and again this is something that the Chinese government recognises) is the existence of a number of items that are associated with western style democracy: the rule of law, decent living conditions and an environment in which it is possible to bring up a family and better yourself. With these things available but without the opportunity to choose your leader directly, many Chinese consider it a small price to pay.
Finally, it is worth ending with a word on portfolio positioning. Our Asia ex Japan equity portfolios generally have overweight positions in China/HK relative to their benchmark and have done for a number of years. In terms of asset allocation, this would not have been correct, but we do not own the index, we select stocks.
Stocks such as Jardine Matheson, one of our biggest holdings, have been great for us in terms of total return for nearly a decade. In the last couple of years Hengan and Daphne have added a significant amount of value to our portfolios. We also have high expectations for a number of our internet gaming-related stocks.
However, I consider the Chinese market to be cheap for a reason: even at low valuations too many of its index components are likely to be value traps as the rate of economic growth slows and these companies are unable to adapt successfully.
But there is a huge opportunity in the stocks that can tap into Chinese growth and that have not already become overvalued.
Stuart Parks is head of Asian equities at Invesco Perpetual. The views expressed here are his own.