China, which last year surpassed Japan as the world’s second largest economy with a GDP of nearly $6,000bn (€4,204bn), could overtake the US if it maintains annual growth of 8 per cent over the next 20 years, according to the World Bank.
Even though China achieved an important milestone, the government itself was quick to point out its economy is still at a developing stage: China remains a rich country with poor people, as the per capita GDP is only around $4,000 per year.
This underlies the Chinese leadership’s determination to diversify the country’s economic structure, to tame inflation, reduce income disparity and improve social safety nets. These objectives are reflected in the 12th Five-Year plan, which officially started in March this year, where China’s previous emphasis on exports and investments is shifted towards consumption and from urban and coastal growth towards rural and inland development.
“As more pro-consumption policies are introduced in the coming years, the intensity of the economy, represented by consumption/GDP ratio, should rise significantly,” believes Raymond Ma, manager of the Fidelity China Consumer Fund. “As a proxy of China’s economic model, we expect the weighting of consumer-related sectors in the MSCI China index to growth substantially.”
Over the next five years, China’s consumer-related sectors are likely to outperform the broader market and double or even triple their market capitalisation, says Mr Ma.
With its 1.3bn population, China’s consumption boom is now spreading from the top affluent groups to the middle class, and is expected to move towards lower income group over the next five to 10 years. Strong income growth and a rise in the affluent middle class population have driven an increase in higher-end discretionary spending, as people become increasingly aware of quality, brands and fashion.
By investing in consumer-related sectors, investors can gain exposure to the emerging middle classes and their “consumption upgrade”, says Mr Ma.
Making money
However, it is important to correct the misconception that all sectors benefiting from government policies will outperform, emphasises Yonghao Pu, head of wealth management research Asia-Pacific at UBS. “To follow blindly the policy initiative is not necessarily a good investment decision. Government policies do not necessarily translate into companies’ profits,” he says.
The Chinese government stimulus package in 2009, for example, was particularly supportive of the infrastructure sector but because of low pricing conditions, companies did not generate a lot of profits. “You need to look at the cost and the pricing power issues,” says Mr Pu.
Chinese companies require much higher levels of due diligence than European firms, he states. It is important to understand the language, to monitor local press and reports, and to be able to have regular dialogue with management about how they price products and manage inflation.
Having a good brand is also important, as is the company’s ability to bring innovation. The Chinese government strongly supports firms that are able to innovate, giving them freedom in pricing their goods, which can be translated into profits, claims Mr Pu.
As nominal salaries have increased 15-20 per cent over the last two years, companies to favour are those that are not labour intensive, that can increase productivity and add intellectual value. Also they should not be raw material intensive, as the increasing cost of commodities can eat into margins. Industry automation and upgrading is an important investment theme going forward, says Mr Pu.
“Government policies impact investment decisions quite a lot these days,” says Samantha Ho, investment director of Invesco Hong Kong and portfolio manager of the Invesco China Fund. For example, companies with exposure to western rural areas will benefit greatly from the “Go West” policy launched by the government to develop China’s Western region, which still lags behind more developed coastal areas.
Many companies borrowed for expansion recently and may be particularly affected by interest rate increases and monetary tightening. Administrative measures to fight inflation include price controls, which can squeeze margins of companies selling these products. So it is important to carry out a Swot (strengths, weaknesses, opportunities and threats) analysis of each company, says Ms Ho.
Understanding the motives behind government action can be vital. Normally, the government will look at the numbers before they make any decision, she says. For example, if statistical indicators show the economy overheating or slowing, the authorities will start to calm or stimulate the market.
“In China, there is just one political party, so you don’t have to worry about them fighting all the time to please voters,” she says. “You know the major concern for them is social stability.”
Last year’s policy initiative to boost blue-collar wages, combined with the plan to develop inland and western areas of China, particularly for technology manufacturing, is putting a strain on salaries. People are staying close to home in western China, and companies will have to raise salaries even more to attract people, further hitting margins.
