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China on-site: debt concerns and consumption upgrades

China on-site: debt concerns and consumption upgrades

01-11-2017 | Insight

This new bi-monthly publication discusses both a key concern and a key opportunity in China. In this edition, we examine China’s debt position and the growing importance of consumption for the country’s economic growth.

  • Victoria  Mio
    Victoria
    Mio
    CIO China, co-Head Asia Pacific Equities, Fund Manager Robeco Chinese Equities
  • Jie Lu
    Jie
    Lu
    Head of Research China
  • Hauke Ris
    Hauke
    Ris
    Head of Client Portfolio Management Equity

Speed read

  • China’s high debt levels are a much heard concern among investors
  • China’s debt financing is mainly domestic and debt composition is changing
  • Rapid growth in consumption is an opportunity for investors

Concern: China’s debt

Debt in China is building up rapidly. Over the period from 2008 to 2016, it increased by 131.9%, against 43.6% for Japan and 65.2% for Canada. It is therefore a much heard concern among investors. We agree that it poses a risk and it certainly needs to be monitored closely. However, we would point out that a high level of debt-to-GDP does not automatically result in crisis. Other countries, including developed ones, have much higher debt-to-GDP levels and do well. Last year, China’s debt-to-GDP ratio was 277%, against, for example, 461% for Japan and 290% for the EU. This is illustrated in the figure below.

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Debt to GDP ratio, 2016

Source: CEIC Data Company Ltd., Haver, Morgan Stanley Research

In addition, the way in which debt is financed is relevant. In China, debt financing is healthy, as the country relies mainly on domestic financing for its debt. Exposure to external debt is one of the lowest among the major countries. In 2016, China’s external debt amounted to 13% of GDP, compared with  97% for the United States and 141% for Germany. Although the savings rate is declining, the absolute level is still high enough for debt growth not to outpace deposit growth.

The Chinese government is taking measures to change the debt composition. Leverage is higher in the corporate sector, whereas households and the government are relatively unleveraged. Currently, debt is being shifted towards households and the government. This will help repair corporate sector balance sheets and lower the overall cost of financing, as the government’s share of debt increases and it can borrow at a lower  rate. This will allow China to maintain a relatively fast economic growth rate.

Opportunity: China’s consumption upgrade

The contribution of consumption to China’s GDP is growing rapidly, which creates opportunities for investors. China’s consumption is expected to grow by USD 2.3 trillion by 2020 (see the figure below). This amounts to a compound annual growth rate (CAGR) of 9%, which outpaces GDP growth.

Nominal private consumption, 2020 (USD trillions)

Source: Economist Intelligent Unit, BCG. Assuming annual GDP growth of 5.5%.

In other BRIC countries and major developed markets, consumption accounts for 60% to 80% of GDP. China’s consumption is catching up quickly and has already reached 52%. This is shown in the bar chart below.

Consumption as a % of GDP

Source: IMF, Ant Finance Institution, Robeco

Consumption growth will be driven by two factors. The first one is an increase in income. The Chinese government targets a 7% CAGR of the average income per capita by 2020. The second consumption growth driver is  a lower savings rate. The government will stimulate a lower savings rate by:

  1. Expanding social insurance coverage, to increase consumer confidence and leave consumers with more money to spend 
  2. Developing the consumer credit market 
  3. Lowering consumption-related taxes, which is part of the government’s policy

The composition of consumption will also change. China’s middle class is growing, with rising wages to spend. We expect this part of the population to account for a 22% CAGR in spending by 2020. The middle class spends more on luxury items, which creates investment opportunities in the consumer discretionary sector.

Next to the expanding middle class, there is a growing group of aging, wealthy Chinese that will spend more on services, such as financial services and health care. This group will reach 25% of the population in 2030, compared with 15% in 2013. 

Finally, young adults are spending more and more on entertainment and innovative products. This is benefiting sectors such as technology and discretionary consumer goods. Young adults are expected to contribute 35% to total consumption in 2020.

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