How Can China Remain a Key Growth Economy?

It is no secret that China faces a number of headwinds, including slowing growth, a high debt-to-GDP ratio, an ageing population and Covid-19.

But much has changed since the outbreak of the virus more than a year ago. With an annual growth rate of 2.3% for 2020, China is the only major economy to have expanded last year.¹  Official data from the National Bureau of Statistics show that GDP increased by 6.5% in the fourth quarter of 2020.

When it comes to Chinese equities, though, nominal income aggregates such as household incomes and wealth represent more important growth metrics than GDP growth. This is good news for equity investors as the middle class in China continues to grow. According to a brief by HSBC’s Herald van der Linde, head of equity strategy, Asia-Pacific, 47 million Chinese already live in households with annual incomes of more than US$50,000.²

Wenli Zheng, regional portfolio manager at T. Rowe Price, expects this number to increase over four times in the next 20 years, making the story of the Chinese consumer ‘one of the world’s most exciting for equity investors’.

‘China will remain a key growth economy over the next decade and as they open up their markets, investors will want more exposure,’ Edward Moya, senior market analyst at forex trader Oanda, believes. Investors, he says, will focus on the country’s longer-term transformation to a consumption-led economy.

But the transition away from an economic model based on fixed-asset investments and lower value exports to one driven by domestic consumption has caused China’s growth pace to slow down. From dizzying double-digit figures, pre-pandemic GDP growth went to a more sustainable level of 6.1% in 2019.³

Chris Kushlis, emerging markets sovereign analyst at T. Rowe Price, said: ‘From around 2006, the Chinese government began trying to rebalance the economy, moving away from a predominantly export-driven model, toward a more domestic-based model. This shift is aimed at engineering more sustainable, long-term growth. Further slowing in the rate of growth is likely as this transition continues.’

Rising middle class

Today, China’s growth is driven primarily by the steady expansion of the wealthy middle class, which has been particularly beneficial for education and consumption-led areas of the economy, including education, tourism, insurance and automobiles.

Ecommerce is also booming. China continues to be the largest online retail market, with revenue expected to grow to more than US$1,4tn in 2024.⁴ Last year alone, 24.9% of the total retail sales in the country were made online, up from 20.7% in 2019.⁵

At the same time, China is finding answers to its ageing population problem in pharmaceutical developments. With over 4,000 pharmaceutical players, China represents the second-largest pharma market globally, with a vast growth potential that is fuelled by government initiatives.⁶

The economic transition has also meant a shift away from state-owned enterprises, with China’s private sector contributing over 60% of the country’s GDP.⁷ That leads to a greater focus on corporate governance, transparency and quality of management.

On the up

Concurrently, China’s market is opening up to international investment. The inclusion of domestic A-Shares in the FTSE Russell global equity benchmarks from June 2019 as well as the Bond Connect scheme unveiled in 2017 and the Shanghai/Hong Kong Stock Connect scheme launched in 2014 are driving foreign direct investment (FDI) into a country that has historically been difficult to access for international investors.

The United Nations Conference on Trade and Development suggests that China was the world’s largest FDI recipient in 2020, with a 4% increase in inflows to $163bn. That stands in stark contrast to global FDI, which fell by 42% last year.

The purchase of Chinese equities and bonds is unlikely to slow down any time soon. According to the People's Bank of China (PBoC), foreign investors held a record ¥2.46tn in Chinese stocks in June 2020, up 50% from a year earlier. Meanwhile, bond holdings surged by 27% to an all-time high of ¥2.57tn over the same period.

But it doesn’t end there. With China’s economy fully recovered to pre-pandemic levels, policymakers have turned their attention back to reducing the country’s growing debt burden. ‘Authorities have recently moved to arrest the ballooning level of debt. There is still more to do, but progress has been made,’ Kushlis noted.

In recent months, the central bank has also adopted a more conservative stance - away from reserve ratios and interest rate cuts - that reflects the country’s way back to normal. After all, the PBoC has many weapons in its arsenal to help manage and ensure the stability of China’s economy throughout 2021 and beyond.

 

Emerging markets are less established than developed markets and therefore involve higher risks.