单伟健 中国会继续增长吗 Will China Continue to Grow

WillChinaContinuetoGrow?

WeijianShan

November14,2023

AtPAG’s2023InvestorConference,heldinHongKongonNovember8,Co-FounderandExecutiveChairmanWeijianShanaddressedinvestorsonthestateoftheChineseeconomy.Despitedomesticchallengesandbroadergeopoliticalconflicts,ChinaisexpectedtomeetitsGDPgrowthtargetof5%fortheyear.Butcanthisgrowthbesustained?Shan’saddresslookedatChina’sabilitytorespondtoeconomicchallengesfrombothamonetaryandfiscalperspective,aswellassomeoftheemergingtrends,sectorsandtechnologiesthathavethepotentialtotransformChina’seconomiclandscape.

BelowisatranscriptofShan’sremarks,editedforclarity.

Thegrowth–orlackthereof–oftheChineseeconomymatters.NotonlytoChinaitselfandtoforeigninvestors,butalsototherestoftheworld,asChinaisnowthelargesttradingpartnerofmorethan140nations.AsaprivateequityinvestmentfirmfocusedontheAsia-Pacificregion,PAG’saddressablemarkethasacombinedGDPofaboutUSD33trillion.China’sGDPisaboutUSD18trillion,whichrepresentsmorethanhalfofthat.China’sGDPisaboutfourtimesthesizeofJapan,sixtimesthesizeofIndia,andsixtimesthesizeofthe10AssociationofSoutheastAsianNations(ASEAN)combined.Itis10timesthesizeofSouthKorea,and12timesthesizeofAustralia.ItsGDPisabout80%thatoftheUnitedStatesandisbiggerthanall27countriesoftheEuropeanUnionputtogether.AccordingtotheInternationalMonetaryFund(IMF),China’sshareoftheworldeconomy,asof2023,isabout18.5%,anditcontributestoabout35%oftheworld’sgrowth.

China’sChallenges

Exhibit1:TheAdjustmentinRealEstatehasLargelyDrivenEconomicSlowdown

ChineseGDPbysector(2019=100,%shareofGDPinbrackets)

Source:FinancialTimes

TheChineseeconomyhasexperiencedseverechallengessince2022particularlyintherealestatesector.Exhibit1,whichIborrowedfromMartinWolfoftheFinancialTimes,showsthattherealestatesector,whichdirectlyaccountsfor11%ofGDP(andindirectlyforabout25%),hasfarunderperformedothersectorsoftheeconomy,whichhavemoreorlessresumedtheirpre-pandemicgrowthtrajectory.China’srealestatesectorinfacthasbeenanegativecontributortoChina’soveralleconomicgrowthsince2022andadriveroftherecenteconomicslowdown.

Exhibit2:PropertyisBiggestDragonGrowthbutitsWoesMaybeTaperingOff

ContributionofProperty-relatedActivitiestoGDPGrowth(%points)

Source:FinancialTimes

Whilethepropertysectoristhebiggestdragontheeconomy,itswoesmaybetaperingoff.AsExhibit2shows,thesector’snegativecontributiontoGDPgrowthhasnarrowedfromabout4%in2022tolessthan2%in2023.

Chinawillmeetitsgrowthtargetofabout5%thisyear.Infact,itwasreportedonNovember8thattheIMFhasreviseditsforecastupto5.4%.Forecastsbyvariousinstitutionshavegyratedquitewidelyfrommonthtomonththisyear,reflectinganunevenpathofeconomicrecovery.Butwhat’sthepointofmakingforecastifitchangesmonthly?AtPAG,wehavenotdoubtedthetargetgrowthnumbersinceitwasfirstreleased.ThisisbecausewebelievethatChinahas“quiteabitofpolicyspace,”inthewordsofU.S.TreasurySecretaryDr.JanetYellen,tohelpitachieveitseconomictargetswhennecessary.Infact,itmayhavemoresuchpolicyspacethananyothermajoreconomyintheworld.

China’sPolicySpace

Exhibit3:SpaceinMonetaryPolicy

1.NoinflationandnegativeProducerPriceIndex

2.Lendingratesremainat4-4.5%

3.Largebanks’CashRequirementRatio(CRR)withcentralbankat10.5%,comparedwith0-1%forWesterncountries

RealinterestratehigherinChinathantheUSandEU

AsexplainedinExhibit3,unlikemanyothercountriesinthedevelopedworld,Chinaisexperiencingnoinflation.ForOctober,itsConsumerPriceIndexwas-0.2%,whilecoreinflation(excludingfoodandfuel)is0.6%.ItsProducerPriceIndexdropped2.6%.However,Chinahascomparativelyhighinterestrates:theprevailinglendingrateshoveraround4-4.5%.Therefore,itsrealinterestrate–thenominalinterestrateminustheinflationrate–isstillhigherthanintheUnitedStatesandmuchhigherthaninEuropeorJapan.ItsCashReserveRatio(CRR)–thepercentageofdepositsthatcommercialbanksmustparkwiththecentralbank–isaround10.5%forlargebanks,comparedwith0-1%forwesterncountries.Therefore,China’smonetarypolicyhasroomtoeasebyeithercuttinginterestratesorCRRorboth,whichnoothermajoreconomycan.

Onthefiscalside,asshowninExhibit4,Chinaissimilarlyinaleagueofitsownamongsizableeconomies:itsbalancesheetshowspositivefinancialnetworth,whereasothers,suchastheUnitedStates,JapanandGermany,aredeeplyinthenegativeterritory.Muchinkhasbeenspilledbytheworld’spunditsaboutChina’sgovernmentdebt.Intruth,Chinesecentralgovernmentdebtrepresentsonlyabout21%ofGDP.Localgovernmentdebt,ofcourse,iswhathasbeengettingalltheattention.Butestimatesfortheseobligationsrangeonlyfrom50%to80%GDP,includinghiddenliabilities.Ifwetakethehighestdebt-to-GDPratioof110%forChina’soverallgovernmentdebt,itstillcomparesfavorablywiththatoftheU.S.federalgovernment,whichisabout140%ofGDP,andwithJapan’scentralgovernmentdebtofabout260%ofGDP.Furthermore,thefinancialassetsownedbytheChinesegovernmentexceeditstotalfinancialliabilities,asIMF’sstudyshows.

Exhibit4:ChineseGovernmentHasaPositiveNetFinancialWorth(orNegativeNetDebt)

GeneralGovernmentFinancialBalanceSheetforSelectedCountries(Percentof2019GDP)

sourcesvariousvia

Thenetassetvalue(NAV)–totalassetsminustotalliabilities–ofChina’sstate-ownedenterprises(SOEs)representsabout70%ofGDP.Thecountry’sprivately-ownedenterprisestradeinthestockmarketatamedianprice-to-NAVmultipleof5.4times.Ifweapplyonly2timestoSOEswhichareconsideredlessefficient,themarketequityvalueofSOEsamountstoabout140%GDP,exceedingthetotaldebts,bytheirbroadestmeasure,ofthecentralandlocalgovernmentsbyabout30%GDP.ItshouldbenotedthatalmostalloftheChinesegovernment’sdebtisinlocalcurrency.ItsforeigncurrencydenominateddebtisnegligibleasapercentageofGDP.ItshouldalsobenotedthatnotcountedinthesecalculationsareChina’svastlandandnaturalresources,allofwhicharegovernment-owned.Therefore,thefiscalpolicyoftheChinesegovernmenthasplentyroomtoexpand.

HealthofChina’sBankingSystem

WilltheslumpinthehousingsectorleadtoafinancialcrisisasitdidintheUnitedStatesandEuropein2008?ManypunditshaverungthealarmbycallingthetroublesfacingthedistressedpropertydeveloperEvergrande,“China’sLehmanmoment”–referringtothedemiseoftheonceveneratedAmericanbankwhichtriggeredthe2008FinancialCrisis.Buttheanswerisno.

Exhibit5:NoSystemicRiskinFinancialSystem

1.Loantovalueratioformortgagesinmajorcitiesisat~40%

2.Mortgagesareunlimitedpersonalliabilities–riskofdefaultverylow3.Developerloansrepresentlessthan6%totalloansandaresecured

4.CapitalAdequacyRatiomorethan15%forbankingsystem

5.Non-PerformingLoanRatioat1.6%

6.NPLreservecoverageratioatabout150%

Housingproblemswillnotleadtoabankingcrisis

ThereasonsarelaidoutinExhibit5.TheaverageloantovalueratioofmortgagesinChina’smajorcitiesisabout40%,whichmeansthathousingpriceswillhavetofallmorethanhalftoproducenegativeequityforhomeowners–i.e.,wheretheirhouseisworthlessthanthemoneytheyoweonit.Thatisnotevenremotelylikelytohappen.Moreover,Chinesehomeownerscannotsimplywalkawayfromtheirmortgagesifthathappens,ashomeownerscanintheUnitedStates.InmainlandChina,asinHongKongandAustralia,amongotherjurisdictions,mortgagesareunlimitedpersonalliabilities.Thatiswhyduringthe1997AsianFinancialCrisis,therewasplentyofnegativeequityinHongKong’shousingsector,butnotasinglebankfailure.

Infact,theChinesebankingsystemhasexperiencedanoppositeproblem–toomuchcashfromprepaidmortgagesandabove-normalsavings.Prepaidmortgagesamountto12%ofallmortgagesinthebankingsystemsince2022.HouseholdsavingsincreasedmorethantheirnormallevelsbyRMB18trillion(USD2.5trillion)in2022andRMB12trillion(USD1.6trillion)justinthefirsthalfofthisyear.

Residualloanstopropertydevelopersrepresentlessthan6%oftheloanbookinthebankingsystem,andallofthoseloansaresecuredbycollaterals.Chinesebanksarewellcapitalized,withanaveragecapitaladequacyratioofmorethan15%,andtheiraveragenon-performingloan(NPL)ratioisabout1.6%.Yes,NPLshavebeenrisinginrecentyears.ButbanksaresellingorwritingthemoffquicklybecausetheregulatoryrequirementinChinaforsettingasidereservestocoverNPLsismorethan100%,morethananyothercountryIknowof.Therefore,itisjustnotworthitforChinesebankstoholdontoNPLs.

China’sAvenuesforGrowth

Exhibit6:IfNotProperties,WhatDrivesGrowth?

BreakdownofChina’sEconomicGrowth,2022

Sources:ViaKKR

Thisdoesn’tmeantherewillnotbeanyshort-term–orpotentiallylonger-term–paininChina’srealestatesector;IamonlysayingthatChina’srealestateissueswillnotinfectthebankingsystemasawhole.TherealestatesectorstillisanegativecontributortoChina’sgrowth,asIdiscussedearlier.So,ifpropertieswillnolongerdriveeconomicgrowth,whatwill?

Exhibit6istakenfromKKR’srecentpublication,ThoughtsfromtheRoad–Asia.Itshowsthatin2022,the“GreenEconomy”andthe“DigitalEconomy”added4.7%toChina’sgrowthrate,morethanoffsettingthenegativecontributionof3.7%bytherealestatesector.

Exhibit7:WorldLeaderintheFourthIndustrialRevolution

China’sGlobalShare,%

source:variousviaKKRandauthor'sownresearch

Indeed,Chinaleadstheworldintheindustriesenabling,andenabledby,theFourthIndustrialRevolution–greenenergy,digitalization,industrialrobots,artificialintelligence,etc.Exhibit7isbasedonasimilarchartfromKKR’spaperandIaddedacouplemoresectors.Theseareallgrowthindustries,dominatedbytheprivatesector(withtheexceptionofhigh-speedtrainsandtosomeextentsemiconductorfoundries).ChinahassurpassedJapanasthelargestexporterofcarsthisyear–andaquarterofthoseareelectricvehicles.Inlithiumbatteries,anessentialcomponentofelectricvehicles,mobilephonesandotherindustriesonthislist,Chinawentfromzeropercentoftheglobalmarketin2005to63%–nearlytwothirds–today.Ithasmarkedsimilargrowthinwindpowerandindustrialrobotinstallation.Ishouldnotehoweverthatdespitetheirlargemarketshareandrapidgrowth,wedon’tconsidermostofthesesectorsattractiveforprivateequityinvestment,becausetheyarepronetoover-competitionandovercapacity,andthereforelowprofitability.

TheU.S.-ChinaTradeWar

HowmuchimpacthasthetradewarhadonChina’sexports?Exhibit8showsthatithasnotdampenedU.S.-Chinatradeandindeedthebilateraltradereachedanall-timehighofaboutUSD700billionlastyear.Eventhen,directtradedoesnottellthefullstory.

Exhibit8:TradeWarHasNotDampenedUS/ChinaTrade

Source:ChinaCustoms,USCensusBureau,MorganStanleyResearch

Exhibit9:China’sIndirectExportstoUSviaVietnam

Source:IMF,MorganStanleyResearch

TakealookatExhibit9.Ontheleft-handside,sincethestartoftheU.S.-Chinatradewarin2018,Vietnam’sexportstotheUnitedStateshavesurged,butitsimportsfromChinahaveincreasedevenfurther.Thechartontheright-handsideismorestriking.Vietnam’simportsofintermediateproductsfromChinafarexceeditsexportsoffinalproductstotheUnitedStates.Ineffect,VietnamcanbeseenasaconduitforChina’sindirectexportstotheU.S.

Exhibit10:China’sIndirectExportstoUSviaASEANCountriesSurge

Source:IMF,MorganStanleyResearch

Vietnamisoneofthe10membersofASEAN.In2020,ASEANreplacedtheU.S.tobecomeChina’slargesttradingpartner.Asshownontheleft-handsideofExhibit10,ASEAN’sexportstotheUnitedStateswentupsharplysincethestartofU.S.-Chinatradewar,butitsimportsfromChinagrewevenfaster.Thechartontheright-handsideshowsthatASEAN’simportsofintermediateproductsfromChinafaroutpaceitsexportsoffinalproductstotheUnitedStates.

ThesamestoryisrepeatedeveninIndia,asshowninExhibit11.

So,whatisgoingonhere?PleaseseeExhibit12.China’smanufacturingisdeepening,i.e.,itismovingupthevaluechainintotheproductionofhigher-value,higher-technologyproductsandcomponents.Itstotalshareoftheworld’smanufacturingvalue-addedkeepsrising,nowrepresenting31%.

InanarticleIpublishedin2019,InotedthatChina’svalue-addedtoAppleiPhonesrepresentedonlyabout4%ofeachphone’sretailvalue.AnarticlepublishedinForeignAffairsthisyearnotesthatvalue-addednumberhasclimbedto25%.ThatisthebestexampleofhowfastChina’smanufacturingisdeepening.

Exhibit11:China’sIndirectExportstoUSviaIndiaJump

Source:IMF,MorganStanleyResearch

Exhibit12:China’sManufacturingisDeepeningandRising

ShareofWorldManufacturingValue-added,BySource

Source:

/2023/06/13/breaking

-down-chinas-manufacturing/

Exhibit13:AppleHasMadeLittleProgressMovingManufacturingoutofChina

Wheredevicesaremanufactured(%)

Source:FinancialTimes

ThathelpsexplainwhyAppleissoattachedtomanufacturinginChina,whichalsonowhappenstobetheworld’slargestmarketforApple’siPhone.AstheFinancialTimesreported,showninExhibit13,Apple’seffortstodiversifymanufacturingawayfromChinawillmakealmostnodifferenceintheforeseeablefuture.

China’sTechnologicalProgress

Alongsidethelong-runningtradewar,thereisnowalsoatechnologywar,astheUnitedStateshasbannedhigh-techexportstoChinainareasrangingfromadvancedsemiconductorchipstoquantumcomputingandAI.WillthepolicycontainChina’stechnologicalprogress?

Intheshortrun,yes,itwilldampenChina’stechnologicalcapacity.Butinthelongrun,itwillnot.Chinahasastrongtechnologicalbase,whichexportbansareunlikelytoaffect;ithasthemeanstocatchupinareasitisbehind,owingtoitsyearsofvalue-addedmanufacturingandinnovation;andthankstotheexportbans,ithasastrongincentivetodevelopitsownversionsofnow-unavailabletechnologies.

WhenIwasaprofessorattheWhartonSchool,Istudiedthethen-nascentbiotechnologyindustry.IaskedmyselfwhybiotechnologyandSiliconValleyweresuchauniquelyAmericanphenomenon,eventhoughEuropeandJapanwerealsorichdevelopedcountries.Whatdoesittakeforacountrytobecomeahightechnologyhotbedandhub?IcameupwithfivenecessaryconditionsassummarizedinExhibit14.

Exhibit14:FiveNecessaryConditionsforHigh-TechLeadership

ChinanowpossessesallfiveoftheconditionsIoutlined,whichtogetheraresufficientforittocatchupinalmostanytechnology,andtotaketheleadinsome.Itisjustamatteroftime.Infact,China’spaceofinnovationwillonlyberetardedifthelikesofQualcommandNvidiaarepermittedtocontinuetoselltoanddominatetheChinesemarket,becausetheirproductsarecurrentlybetterandcheaper.ButtheexportbansbytheU.S.openupthedomesticmarketforChinesefirmstoacceleratetheirtechnologicalprogress.

Idon’tneedtodwellonthoseconditionsthatareobvious.Butmostnotably,capitalisnoconstraintforChinaasitisnowacapitalrichcountry.Itssavingsrateisinacategoryofitsownamongsizableeconomies,aspointedoutbyMartinWolfoftheFinancialTimesandshowninExhibit15.ChinaisalsoaleadingcreditornationincludingtotheU.S.governmentbyitsholdingsofU.S.TreasuriesandAgencyBonds.

ItshouldcomeasnosurprisethattheU.S.andChinaleadtheworldinR&Dspending,accordingtotheWallStreetJournalinExhibit16.SincethesizeofChina’seconomyisabout80%thatoftheU.S.,itsR&DspendingasapercentageofGDPisaboutthesameas,ifnotmorethan,America’s.

Exhibit15:China’sSavingsRateisinCategoryofItsOwnAmongSizeableEconomies

GrossNationalSavingsasa%ofGDP,2023,SelectedCountries

Source:FinancialTimes

Exhibit16:TheU.S.andChinaLeadtheWorldinR&DSpending

sourceThewalstreetJournal

Exhibit17:ChinahasOvertakenU.S.inScientificPapersPublishedinRespected

JournalsAnnually

sourceThewalstreetJourna

Furthermore,astheWSJnotes,inExhibit17,ChinahasovertakentheU.S.inscientificpaperspublishedinpeer-reviewed,respectedinternationaljournalsannually.

Exhibit18:PatentingActivityinChinaHasIncreasedExplosively

Patentapplications(mn)underPatentCooperationTreaty

Source:FinancialTimes

AndtheFinancialTimesgaveusExhibit18,whichshowsthatChina’spatentingactivityhasincreased“explosively”(MartinWolf’sword).ThenumberofpatentapplicationsinChinaperyearisnowmorethantheU.S.,Europe,JapanandSouthKoreacombined.

Exhibit19:Paradox:High-TechBansInduceTechnologicalAcceleration?

ChinaBreakthroughsReportedinForeignPublicationsinJustLast3Months

Paradoxically,high-techsanctionsonChinahaveinducedanaccelerationintechnologicalprogress.Exhibit19showsafewselectedheadlinesfromtheglobalscientificjournalsandpressonChina’stechnologicalbreakthroughsinjustpast3months.Alloftheseexceptthelastone,thecancerdrugrecentlyapprovedbytheU.S.Food&DrugAdministration,concernareasontheUSsanctionslist.

DemographicBomb–orBust?

TheacceptedopinionisthatChina’sdemographics,namelyanaginganddecliningpopulation,willultimatelythwartitslong-termgrowth.Butthedatadoesn’tsupportit.

Exhibit20:DemographicsWillUnlikelyStopLong-TermGrowth

1.ThesizeofChina’slaborforcepeakedin2012

2.GDPhasdoubledin10yearssincethen

3.R&DandproductivityincreasewillallowChinatoavoid“middleincometrap”

4.Mandatoryretirementagestilltoolow:60formen,55forwhite-collarand50for

blue-collarwomen

5.Urbanizationrateisonly65%,comparedwith91%forJapanand85%fortheUS

IoutlineafewreasonsshowninExhibit20.ThesizeofChina’slaborforceplateauedin2012andbegantograduallydecline.YetitsGDPhasdoubledinthe10yearssincethen.Yes,China’sproductivityincreasehasslowedinrecentyears,butithasstillmanagedtopropeleconomicgrowth.

SomebelievethatChinaisprimedtofallintothe“middleincometrap”thathasmiredsomanydevelopingeconomies,particularlythoseinLatinAmerica.Yethere,China’sR&Dspendingandproductivityincreasessetitapart.Chinaisnowattheforefrontofindustrialautomation,asevidencedbyhavinginstalled50%oftheworld’sindustrialrobots.ItisunlikelythatChina’sdemographicswillcausealaborshortageintheforeseeablefuture;infact,itslaborforceislikelytobesignificantlyunderutilized,forreasonslaiddownonthisslide.

AsoneU.S.basedinvestorpointedouttome,iftheinternationalinvestmentcommunityissobullishonJapan,whichhasworsedemographicissues,whynotChina?

TheChinaOpportunity

Fromaprivateequitystandpoint,PAGislong-termpositiveonChina.AsIsaidearlier,weavoid“hot”sectorspronetoover-competition.Sowherearewelookingtoinvest?Theanswerisinleadingbusinessesthatcatertoprivatec