As urbanisation continues to sink its claws into the emerging market titan, a huge amount of growth is being created. In fact, the International Monetary Fund estimates that China accounted for one-third of all global growth last year.
But that’s not necessarily shown in headlines declaring China’s economy a sinking ship. It is well-known that the country’s economy has begun to slow down, dropping from 7.7 per cent growth in 2012 and 2013 to 7.4 per cent in 2014.
Capital Economics predicts that growth will slump to 6.8 per cent in the first quarter, based on weak data and potential jitters over a ‘hard landing’.
Of course, it’s a mathematic fact that the larger the economy gets, the harder it will become to maintain the huge growth rates of the past. In fact, the larger size of China’s economy means its increase in 2014 was 100 per cent greater than the increase 10 years ago when GDP grew by 10 per cent from a much smaller base.
Meanwhile, income has increased by approximately 7 per cent in China due to inflation adjustments and spending has risen by 11 per cent over the past year.
These are promising figures, but many views on China are still tainted by the gradual descent of the economy’s growth rate. There is a clear sense of unease towards China, and Matthews Asia investment strategist Andy Rothman answers some of the questions that many investors have been asking themselves before deciding whether to take the plunge.
MSCI China index vs MSCI AC World and MSCI Emerging Markets index over seven years
Source: FE Analytics
Will falling oil prices have a big impact on China?
Emerging markets, particularly countries dependent on natural resources exports, have felt the sting of the plummeting oil prices more than most. However, those that import the commodity to meet their needs benefit from the falls.
Rothman explains that oil accounts for only 18 per cent of China’s energy consumption, which is minimal compared to the 44 per cent usage in Japan and 37 per cent in the US. But the scale of these imports may have helped to drive down oil prices.
“Coal is still king in China and accounts for two-thirds of the country’s energy. In fact, even though China is the world’s largest net oil importer, net oil imports equal less than 3 per cent of China’s GDP,” he said.
“China certainly contributed to weaker global demand for oil last year, with its oil consumption rising by about 1.4 per cent year-over-year, down from 3.2 per cent growth in 2013. But most analysts agree that a big increase in oil supplies was the main factor behind lower prices.”
Is China’s housing market set to crash?
Many people believe that China’s real estate bubble is set to burst at any moment. There’s no doubt that the residential property market is very soft, but Rothman believes that, because of low rates of home ownership and developers reducing the number of new houses, there is little risk of a crash.
He said: “The products that broke Lehman Brothers – and caused havoc through the US financial system – do not exist in China. There are no subprime mortgages and there are very few mortgage-backed securities.”
“There is no secondary securitisation, so no collateralised debt or loan obligations.”
As well as soft prices, volume growth dropped by 9.1 per cent year-on-year after a lucrative year for the Chinese housing market in 2013. While this is perhaps not a step in the right direction for investors, Rothman emphasises that it’s important to retain a sense of perspective.
“Even as sales volume fell last year, that still means that Chinese families bought about 10 million new homes in 2014. That is a lot of new homes, and means there should be a few very profitable developers, especially given that the larger firms are gaining market share.”
What does the growth slowdown really mean for investors?
China has experienced two decades of 10 per cent GDP growth annually, so many investors are disappointed with the way things are heading at the moment in comparison. However, Rothman believes that a slowdown in growth rate was always inevitable.
“Because we are witnessing the odd scene of Communist Party leaders being comfortable with a gradual deceleration of economic growth that is making most foreigners very nervous,” he explained.
“China won’t – and doesn’t need to – ease significantly because current conditions are not ‘tight’, because the macro deceleration is largely the inevitable result of structural changes and because the slower pace of growth is still fast enough.”
Following the initial rapid increase in the workforce, numbers have started to dwindle due to an increasingly aging population. What’s more, housing boomed during the first decade of China’s extreme urbanisation, but of course, that has slowed down now that many people already own homes.
“This slower growth is, however, still pretty fast,” Rothman added. “GDP growth averaged 8.6 per cent between 2010 and 2014, and 7.4 per cent last year: compare this to 2.4 per cent GDP growth in the US for 2014.”
“The absence of a significant stimulus last year is strong evidence that the party is comfortable with this gradual deceleration. The party controls the financial system, and did not reaccelerate credit growth last year.”
What is China’s biggest risk at the moment?
Rothman’s biggest concern is that the evolution in China’s governance and its institutions has not been parallel.
He explained: “China’s economy and society are increasingly based on property rights, yet the country lacks the rule of law which is needed to effectively protect these property rights and ensure a fair, rules-based commercial environment.”
“This is already the source of many problems. Corruption, weakness in industries dependent on intellectual property rights and the widespread theft of land from farmers – the main cause of protests across the country – are all consequences of the lack of rule of law.”
Rothman says the party does not seem to be even remotely tempted to establish the rule of law. He argues that this is because it can exercise more political control over the population without it.
He said: “In the near term, China can continue to thrive, as people find ways to navigate corruption and the opaque system, and as the party works to reduce interference in the legal system by local officials.”
“But as the pace of economic growth inevitably slows over the coming decades, China’s unique form of authoritarian capitalism is unlikely to provide the necessary institutional support for a modern, market-based society.”
While the Chinese market seems to be an area to approach with caution, Rothman is still optimistic about China’s economic prospects from a medium-term perspective, within the context of expecting growth rates to continue to slow.
“This optimism is based in large part on the continuing evolution of government policy designed to embrace private enterprise and markets.”
However, Rothman acknowledges that the party has made drastic and unexpected economic decisions in the past and that the key to China’s long-term financial prospects is how much legal and political freedom the party hands over to its citizens.