China is rebalancing

China is rebalancing

China is rebalancing its economy: from investment-driven to consumption-driven, from quantity to quality growth, and from Old to New Economy.

1. From investments to consumption

The Chinese government wants consumption to become more important as a component of economic growth, compared with investments. This process is well underway.

Less investment
Since 2012, year-on-year growth in manufacturing investment has decelerated, falling from 31.8% in 2011 to 4.1% in October 2017. Overall fixed asset investment growth is set to slow this year from 7.2% in 2017 to around 6%, as the effects of deleveraging and the government’s tightening measures start to kick in. In terms of infrastructure, investment has continued to increase at a brisk pace, but this is expected to decelerate in 2018.

More consumption
Consumption and services are on an upward trend. The willingness and ability of the younger, wealthier generation to consume has spurred a structural spending upgrade in terms of the products they purchase, with booming consumption in information services, smart home appliances, cultural services, tourism, healthcare and education. The stable employment situation, strong labor market and resilient wage growth will continue to boost disposable income and play a key role in GDP growth in 2018.

Source: BofA Merrill Lynch Global Research estimates, Robeco

2. From quantitative to quality growth

The shift from quantity to quality is a much-encompassing theme. We mention four areas where this form of rebalancing manifests itself.

Technology & innovation
China wants to become a leading manufacturing power, driven by technology and innovation. It is getting there:

  • China is already the world’s largest robot market, accounting for 27% of global shipment.
  • It is the world’s largest electrical vehicle market, having sold around 550K new energy cars in 2017 and accounting for 53% of global new energy vehicle sales in 2017.
  • It is the world’s largest smartphone market.

Structural reforms
Quality also means structural reforms. Supply-side reforms aim to eliminate a significant amount of excess capacity, consolidate industries and improve efficiency. State-Owned Enterprises are reformed, with the introduction of, among other things, mixed ownership.

‘Beautiful China’
China is taking measures to protect the environment, in order to safeguard ‘Beautiful China’. Effective from 1 January 2015, the New Environmental Protection Law has significantly increased corporates’ pollution cost because of the high penalties that are being enforced. As of May 2017, the Central Environmental Inspections team had issued 15,586 notices of penalties to the total amount of RMB 775 million. Corporates’ environmental investments have increased to up to 13% of total investments.

Less debt
China’s debt has increased by 131.9% over 2008-2016, against 43.6% for Japan and 65.2% for Canada. The government’s aim is to gradually bring down the debt-to-GDP ratio without causing too sharp a slowdown in growth; to “effectively control leverage” in the economy and to de-risk. The main focus has been on reducing financial system risk, especially shadow banking leverage. Banks are an important source of funding for shadow banking through non-bank financial institutions (NBFI).This form of financing, often via riskier vehicles, ballooned from RMB 7 trillion (USD 1.1 trillion) at the end 2013 to RMB 24 trillion (USD 3.77 trillion) in mid-2016. Since late 2016, tighter rules have led to a decline in banks’ shadow financing activities, with the growth of their claims on NBFI decelerating from 80% YoY in early 2016 to 11% by late 2017.

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3. From Old Economy to New Economy

As China is moving from quantity to quality, another shift takes place in its wake: the one from Old Economy to New Economy. Although it’s hard to cut the boundary between Old and New at MSCI sector or industry lines, New Economy sectors are generally considered to be: Consumer discretionary, Consumer Staples, Healthcare, Technology, Insurance and diversified Financials. Old Economy sectors are Banks, Industrials, Energy, Materials, Telecom (although this is can also be classified under New Economy) & Utilities.

China’s New Economy currently accounts for more than 55% of MSCI China’s market capitalization.

Source: MSCI, BofA Merrill Lynch Global Research, FactSet, Bloomberg. Chart from Google images.
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