The overnight news that China's economic growth forecast was cut is notable in that it brings to mind the complexities (and realities) of the shift from an investment-led economy to consumption-led sustainability. As Bloomberg BRIEF's Economics note pointed out this morning, China is ranked fourth highest out of 170 countries for its reliance on investment (investment-to-GDP of 49%). The fix requires increasing incomes, internationalization of the yuan, and liberalization of interest rates. The latter is perhaps most troublesome (though all are hard to centrally plan together) as the mis-allocation of capital to large cash-rich SOEs relative to the broader (and potentially more growth-tastic) individual borrower or SME leaves what George Magnus of UBS calls a 'sequencing' problem for the powers that be. His concern is that China gets the downside risks of an investment decline before the upside potential from restructuring the economy towards household spending occurs. Critically, the investment-centric economy is not one of industrial capex or export-oriented expansion but inward-facing construction and infrastructure meaning a slowing of investment-led strength is implicitly ending the property boom.
[5]
UBS, George Magnus: China – from investment to consumption
Question: How quickly can China move from a fixed asset investment model to more domestic consumption, given some of the restrictions or limitations they have currently?
George: I wish I knew the answer to that. Even if we assume that there are no political problems in doing this, in terms of what it means for state-owned enterprises and “changing the rules of the game”, as it were, in favour of SMEs and family-run enterprises, I think it takes time, and I think the danger is you get the downside risks of an investment decline before you get the upside potential from the restructuring of the economy towards household consumption and production of goods and services for the household sector.
That to me would be the risk in the strategy. Obviously, you don’t want to achieve a so-called rebalancing simply by having investment go down a plug hole, because although you can rebalance the economy very easily that way the consequences are pretty dire. And even in a managed process there are still risks in terms of the sequencing, and I think it is quite difficult to do quickly.
Jonathan: I have a quick follow-on comment on the China investment themes that George just raised. When we talk about China as an “investment-centric” economy – and this is something that I pound on the table and repeat in any and all forums – it can be very misleading; if you look at the sharp trend rise in China’s investment/GDP ratio over the last ten years, this increase has come predominantly from (i) property construction and (ii) related infrastructure, which would of course include the roads, subways, sewage and everything else that accompanies the housing and property build.
I.e., we’re not really talking about an ever-increasing share of the economy that has gone to, say, traditional SOE industrial capex or export-oriented investment. That is not really what the numbers are telling us over the last ten years in China. And as a result, when we think of “de-investifying” the economy and reducing the investment share, what we are really talking about at the end of the day is turning around the property boom.
And this goes directly to George’s point about the pace of investment decline, whether it comes down slowly or collapses. In China it’s very simple: you want to keep both eyes on the state of property markets. If the property market can stabilize and go sideways for a while and consumption continues to grow, then suddenly you have a more orderly adjustment on your hands. But if property markets are going to collapse or fall sharply over a sustained period of time, then you obviously have much lower hope for an orderly adjustment in this economy.
So the first point I would make for investors and clients listening on the call is “watch property in China”.
Chart: Bloomberg BRIEF [6]