By Kenny Lau
Between the founding of the People’s Republic of China in 1949 and the re-opening of the Chinese market in 1979, China was an inward and isolated country which had fallen way behind the rest of the world; from 1979 to 2009, it gradually became a destination for foreign direct investment and ultimately the world’s factory for consumables. The question is: how China will continue to evolve in the next 30 years, particularly from the perspective of foreign businesses?
“China in modern times seems to operate in cycles of 30 years: the world basically lost China until the opening in 1979; and we are all familiar with the story of incredible Chinese economic growth in the following 30 years,” says William Fung, Group Chairman, Li & Fung Limited. “In 2009, we saw another major turning point – wages of some 800,000 workers at Foxconn were doubled because it was thought to be the cause of a series of suicides among workers in the winter of 2009 and spring of 2010.”
“It was puzzling because some like that does not happen in China unless the All-China Federation of Trade Unions – which is generally more pro-employer and is there to make sure that FDI is not scared away –says it is ok,” he points out. “The fact that it happened signals a change of direction, and China is on a different course of economic expansion. That is, domestic consumption as an engine of growth.”
The dream of reaching Chinese consumers among foreign enterprises was never realized in the previous 30 years, Fung notes. “China never opened up its domestic market, but it is now ready to do so. It is the second promise of China that from 2009 to 2039 it will become the world’s largest consumption market. But it will take a long time because China is a US$10 trillion economy compared with the US at US$18 trillion, with per capita income of only one-seventh of the US.”
“It became very clear when China formulated its 12th Five-Year Plan that it was going to kick-start the consumption market,” he says. “While China has such a big and diverse economy, its five-year plans make it easier to navigate because they often keep strictly to the plan. The general direction is very clear. The track record has been pretty good, and they’ve only missed a couple of times during high volatility.”
Despite current volatility, “I am actually optimistic about Chinese growth, but China will not make six percent growth on consumption alone; investment will make up the difference,” he adds. “And investment will take a different turn: instead of building more steel mills, China will create public good in terms of anti-pollution, clean air and water, and food safety – and these are what people want. The emphasis has shifted quite dramatically.”
The Chinese economic model of the past 30 years has evolved on a scale and at a speed that are largely unprecedented. The growing story of mergers & acquisitions (M&A) in China is simply “mind-boggling,” says Kenneth Hitchner, President of Asia Pacific ex-Japan, Goldman Sachs, highlighting the growth of M&A in China from US$73 billion to US$781 billion in just ten years.
“That is a ten-fold increase at a time when the global M&A market was basically flat. Just last year, it was a 55-percent increase over 2014,” he points out. “Right now, China is 21 percent of the global M&A market. It matters to this ongoing shift because M&A is an enabler through sourcing new technology, management practices, market expansions, and business consolidations.”
“Although this gets characterized a lot in China’s state-owned enterprises (SOEs), I can tell you it is so much more than that,” he continues. “A robust M&A market actually allows companies to flourish on the frontend. In China’s case a circulatory system has to be there to create the shift in this path, to foster both the new economy and the cleanup of the old.”
Nevertheless, China is also facing a number of challenges, including the mounting levels of debt which are not about to fall dramatically any time in the near future, says Ryan Stork, Chairman, Asia Pacific, BlackRock. “While there is a desire to stabilize or perhaps even lower the level of debt, there will be a general trajectory of higher debt levels, and it will manifest itself in different markets.”
Another key issue along China’s new path of growth is the need for a more diversified asset profile, he points out. “Comparing the capital market relative to the investment market, we see a need for diversified capital investment opportunities in China where it is now principally cash, real estate, A shares, and domestic equity markets.” In comparison, the US is a US$65 trillion capital market, a US$40 trillion investment market, and makes up about 20 percent of global GDP; the numbers for China, respectively, are US$13-14 trillion, US$2 trillion, and 15 percent.
A key focus over the near term is about the quality of growth as opposed to the quantity, Stork says. “It will move from hard manufacturing to improving the social elements of the individual in China – whether it is healthcare, education, or similar types of investment. It is also consistent with that construct of exchange of capital flow between international markets and China.”
The current market
Consumer confidence, and hence spending, in China is largely affected by the level of household disposable income and the willingness to spend, Fung notes. “Household income is certainly growing, but people are still fairly uncertain about the economy. There is a lot of problems with state-owned enterprises, and they employ a lot of people.”
“But I would also say that while the willingness to spend is not that great, China has advanced significantly in e-commerce and sales on the Internet, and how it has reached consumers online,” he adds. “And MNCs are shifting from making China a base of production to the focus of selling consumer products to China, but the extent China welcomes foreign enterprises has softened in recent years. It is not unusual to have difficulty when you are trying to break into any domestic market.”
The degree of difficulty is somewhat industry-specific, Hitchner says. “Some will have better access; others won’t. It is a very natural tension in that China is trying to protect and nurture its own industries and to bring to the country the expertise and capability they don’t have. From our perspective, we’d like to have full access to the Chinese market, which is the only market in where we don’t own our entity and are only a minority shareholder.”
“We need to recognize that there are protected barriers in China to allow real interesting companies to be nurtured. We are seeing a first generation of these companies, and they will continue to thrive in what’s not a completely open market,” he says. “I know it is not big enough yet relative to the overall economy in China, but this new economy is very real and is growing very fast.”
And many of the financial services initiatives between China and Hong Kong, including the opening of the fixed income market, stock connect programs with Shanghai and Shenzhen, and exchange of funds, will have further widen access to the China market. “This is a journey with all of these steps, which we may not agree in terms of the pace they are happening, but as a buyer of global liquidity around the world, here is another growing market,” Stork believes.
“We will see the market become more efficient as it becomes more global and more liquid,” he says. “The overall performance of the A shares market over the past 12 months, for example, declined because of deleveraging but also because the market is trading among itself. The desire or the need for long-term diversified capital to make the market two-way is not only healthy for the local markets but also that they function properly as they grow.”
The risk, though, is a precipitous decline in growth and a “quick and decisive” reversal of financial reform, Stork cautions. “If that happens, it could set us back dozens of years, not a couple of years. If the RMB depreciates severely, for example, that’ll bad for China and the whole planet. It’s not just based on China’s actions but those of central banks across the world in the ramification of what global currencies look like and whether it ends up being a race to the bottom.”