Don’t bet against China

Stocks Soaring

If you’re paying attention to international business headlines these days, you might come away thinking that there is big trouble brewing in notso-little China. In a burgeoning economy that became the world’s second-largest on the strength of perennial doubledigit growth, the worm seems to have turned. Gross domestic product grew by “just” seven per cent in the first quarter, the lowest three-month growth in six years. Exports in March were down 15 per cent, and industrial output has grown more weakly than the general economy — a remarkable reversal for a manufacturing powerhouse. India is now poised to become the fastest-growing large economy in the world.

So the buzz words for China’s economic performance these days — “anemic,” “disappointing,” and so on — tell the story everyone seems willing to accept: The miracle is over.

If this really is the case, then nobody seems to have told Chinese investors. The Shanghai composite index is up more than 35 per cent yearto-date, while the Shenzhen exchange, which mostly comprises smaller companies, is up more than 60 per cent. This isn’t just a big-investor rally, either. According to a recent report from BCA Research, there are 125 million investor accounts on the Shanghai exchange, which means that about one in six Chinese urbanites are exposed to equities — three times more than the last big stock rally in 2007.

Do these folks know something the naysayers don’t?

Maybe they do. It’s true that stock markets in China, unlike in developed countries, represent a small part of the economy. They are also notoriously capricious and sentiment-driven. (As one Chinese businessman once told me, “In China, investing is gambling and the stock market is the casino.”) But even if stocks are overheated, and even if a correction is inevitable, there is some good reason to believe that “anemic” China still holds enormous potential for investors. You just have to put those numbers in perspective.

For one thing, slowing growth should be a surprise to precisely nobody. China’s GDP is now US$9.24 trillion. That’s big. And the economy has been maturing, away from primary manufacturing (which is being picked up by satellites like Vietnam) towards tertiary production and services. Growth is slowing because the economy has moved well out of the “startup” phase, and it’s just harder to grow when you’re that big.

As well, Chinese officials have for years been saying their goal is to shift from a manufacturing export- and investment-fuelled economy to a consumer economy. They have also been clear that this will entail some slowdown in economic growth, as the emphasis on wealth production gives way to wealth distribution.

This is a long way from a hard landing. Most big countries would give their central banker’s right arm for China-style “slow” growth. At 6.8 per cent (the International Monetary Fund’s projection for 2015), annual output will grow by more than US$625 billion.

Meanwhile, the long-talked-about transformation to a consumer economy is actually happening. The con-

Consumer clout may present a challenge to China’s social and economic engineers

sumer sector is accounting for a bigger and bigger share of GDP growth, and there is still a lot of potential there. Compared with the United States, where shoppers generate about twothirds of economic activity, consumer spending in China accounts for only about 35 per cent of GDP. Consumer confidence, even dented by a continuing weak real estate market and doom-and-gloom about growth, hit a record high last April.

None of this is to say that the transformation will be smooth or easy, or that success is guaranteed. Chinese consumers are notorious savers — changing them into spenders will take time. But the government is actively taking steps toward encouraging domestic consumption, including recently lowering import tariffs on popular goods and cutting taxes. The central bank has lowered interest rates twice since November and eased reserve requirements in an effort to encourage more lending.

The big question is whether a nominally communist government can really generate a robust consumer sector. It’s harder to play puppeteer to a billion shoppers than a few million factories, and consumers’ growing clout may present a challenge to China’s social and economic engineers. Even short of political unrest, keeping consumers happy and confident enough to spend will be an ongoing problem for policy-makers.

Let’s not forget: China has transformed its economy before. For 20 years, it not only managed doubledigit growth while keeping inflation largely in check, but also pulled nearly 700 million people out of abject poverty.

Whatever you think of China’s politics, there is no denying the scale of that achievement. Maybe China won’t be able to pull off its next transformation, which is perhaps no less daunting or difficult. But I wouldn’t bet against it.