- The longer-term narrative remains intact: urbanisation and the rise of the middle-class consumer
- Consumption habits continue to move online but are fractionalising, moving at a fast pace to social network platforms
- Longer-term growth risks remain around demographics and high public debt
- Technology and infrastructure spending continue to frame growth opportunities
Getting on with urbanisation in the new global order
In two weeks travelling through Singapore, Malaysia, Hong Kong, Beijing and Shanghai we swept through a number of cities, taking in the views of experts. As always, as a countercheck, we also just listened and watched the changing face of Asia. In total, I attended more than 35 presentations and meetings – including sessions with Kevin Rudd and John Kerry, meetings with Huawei and other Chinese companies, and coffees and dinners with Asian portfolio managers. The a2 Milk Company investor conference highlight was the exposure of changing online purchasing platforms, and the revenue opportunity in lower-tier Chinese cities.
There is no doubt that financial markets have been focused on the US-China trade wars, and many of the meetings discussed the current resumption of talks with a more positive tone than expected.
In addition, Hong Kong tensions seemed to have lessened, and in the seven days we spent in the Hong Kong Special Administrative Region (HKSAR), the media became more focused on the root causes of the tensions rather than the protests themselves.
However, by far the most lasting impression of the two weeks was the Chinese focus on the forthcoming 70th celebrations of the forming of the Communist Party. The Chinese policy direction remains firmly on seeking to maintain growth to achieve full employment.
Secondary impressions in Asia revolve around the ubiquitous use of mobile phones, advanced payments systems, the promise of 5G, the problems of the cost of housing and the strong rise of the millennial travellers. Presentations on the further rapid development of artificial intelligence (AI) technology and innovation were reflected in general observations, and further developments in transport infrastructure were obvious from travelling. Asia still has the foot on the accelerator.
I thought it may be useful to lay out these thoughts, tackling perspectives on trade talks first, then Hong Kong and finally sharing broader impressions of China. There are risks in longer-term tensions between demographics and productivity on the one hand and the positive impact of widespread deployment of technology, continued urbanisation, the use of social networks and the broader impact on consumption of 4:2:1 families. When you think about investing in China (and Asia more broadly) the best anchor to ride out volatility and noise in economic data is the longer-term influence of urbanisation.
A deal on the trade war seems more likely
Early in our trip to Hong Kong to attend a major conference with 2,100 analysts and fund managers and over 190 companies, we listened to Kevin Rudd and John Kerry, plus several China experts who gave an impression of the current state of the relationship between the US & China, and the trade war. Unexpectedly, Rudd laid out a road map to the resumption of talks and the potential for both sides to agree to a truce and start real negotiations on what he called phase four of the deal-making.
Our file notes on these meetings draw the conclusion that Presidents Trump and Xi are well incentivised to avoid the 15th December all-in trade war. Neither economy benefits from significant escalation and, while both economies have scope to ease monetary policy further, the political economy for both the US and China suggests there are other priorities for 2020 and beyond.
This isn’t to say however that 2018- 2019 hasn’t marked a significant change in the global political order. The US has turned inward whilst China is set to implement its long-term plan of being a global leader across several industries, spreading its influence in Asia and beyond through the Belt and Road Initiative. Right now, however, the growth signals in China are weak and commentators agreed that Xi needs to be focused on creating the 14 million new jobs needed each year to maintain full employment. Stimulus in China has lifted and by November we should see an improvement in the data; at worst China could cut interest rates and also lift credit growth. However, there is a strong sense that China will want to avoid a sugar rush solution. A trade deal would be a better boost to confidence.
The sticking points on a trade deal are well known and centre on resolving the late in the piece US demands that were rejected by the Politburo in April 2019. The last-minute announcement by Trump doubling his demands for the deal to bring about a US$400 billion reduction in the trade deficit rocked Chinese confidence that any deal could be reached.
Most commentators seem to agree that Trump’s demands would be economically impossible in the near term. However, China also needs to make strong progress on intellectual property laws, following up on the new regulations by establishing some clear case law. There are varying views on how Huawei has become entwined in the trade war, and how technology issues could be resolved. There seems to be no doubt that, for now, China has a jump on 5G, but China also needs US companies in its technology supply chain. Our meetings with Huawei and others suggested that the continuing domestic rollout of 5G is a major Chinese policy goal.
What do we think?
We have revised our likelihood of a meaningful trade deal this year to be the most likely outcome. Rudd said publicly that he was a firm 6/10 that a deal would be done. Markets will be watchful. The failure to bring a deal to signature and the full escalation of the proposed 15th December packages could be significantly damaging to global trade growth in 2020.
Hong Kong has a deep-seated problem with housing affordability
In the eyes of many, Hong Kong sits at the epicentre of three major trading and geopolitical blocks. It remains unique and somewhat volatile, exposed to global trade, China, financial markets and housing uncertainty.
Today Hong Kong has virtually no manufacturing sector. Only 1% of Hong Kong’s exports are domestically produced goods. Instead, financial services, tourism, port and re-export trading comprise key industries. Historically, housing construction has been an important source of growth, along with large infrastructure projects such as the fast train to Shenzen and the extraordinary road to Macau.
Today, Hong Kong is still the world’s third-largest financial market and the proposed takeover of the London Stock Exchange launched this month is part of the plan to have global relevance in the face continued competition from Shanghai as China’s financial hub.
Today, 70% of foreign direct investment into China goes through Hong Kong; banking assets in Hong Kong remain an extraordinary 9 times local GDP.
Why then does a city of 7 million, and a territory of 11 million people, warrant global headlines? Well, that’s an interesting western media question. We think from reading news feeds like Bloomberg, CNN and the Financial Times that the world is ending, starting in Hong Kong. In contrast right now in China, Hong Kong appears a long way down the priority list, which is probably also why the response of China has been more to wait, watch and worry, rather than engage.
Social unrest in Hong Kong has settled down somewhat from mass demonstrations to more sporadic clashes between so-called pro-democracy activists and those that support China with Hong Kong as a Special Administrative Region.
Targeted clashes occurred in the seven days we were in Hong Kong, but none disrupted travel or access or seemed to influence delegates to the large annual financial conference. Local Hong Kong residents, while concerned for everyone’s safety, instead talked about the more deep-seated problems of housing affordability, of governance, and, most importantly, of the negative economic shock stemming from lower tourism.
I had to reflect again on the differences between Singapore and Hong Kong on this trip; why are the differences becoming so stark between these two cities? David Skilling published a piece last week called Singapore and Hong Kong: A tale of two cities which was widely quoted in Asian media sources such as the Straits Times. David has deep experience as an Asian commentator on economics and so his call that the key divergence between Singapore and Hong Kong is housing affordability is worth understanding as a potential cause of social unrest.
The median house price to income in Hong Kong is over 20x, compared to under 5x in Singapore (Source: Demographia, China Times 14 September 2019). Solving this issue is a key policy problem for Hong Kong.
And while New Zealand house prices are not at these extraordinary levels, the long term political implications of solving housing affordability remain a worldwide issue.
In the China Daily last weekend, one of the many papers sanctioned by the Chinese media, a provocative article was pleading for the Hong Kong government to get on and act on home affordability. Stephen Wong of the Our Hong Kong Foundation is quoted as suggesting a lot can be learned from Singapore’s land development policies. Three days later the HKSAR announced a major push for social housing.
It seems likely that meaningful implementation of solutions to the housing crisis in Hong Kong would go some way to reducing tensions. In a way, however, the other major trend of the push back on globalization and global trade seems likely to also be most felt in Hong Kong.
For the immediate future, Hong Kong is suffering significantly from lower tourism, especially from China, where 80% of the visitors come from. Hotel residency was put at only 55% in the week we visited. It was very easy to book restaurants and special deals on accommodation were evident. There was a more marked concern on the flow-on impact on employment, profits and investment.
Anecdotally, I travelled later in the week to Beijing with Cathay Pacific and the normal Friday evening commuter flight was practically empty, perhaps again reflecting the current political fallout between Beijing, the Swire Group and the airline.
The pulse of Beijing
It was a very exciting time to visit Beijing. Firstly, the weekend of the 14-15 September is the Moon Festival and marks a three day weekend for Beijing and surrounding provinces. The weather was superb with blue skies (a first for me in Beijing) and people were out in full force, celebrating with families the fine weekend and the Moon Festival.
We visited the Summer Palace (the third most popular tourist destination in Beijing, with its vast gardens, a huge man-made lake and temples all dating from around 1740). Our guide estimated we were joined by about 200,000 other people and we made observations of what people are wearing, which phones they are using, the role of children in extended families, and the advantage of buying tickets online to avoid queues! Fortunately, we had gone very early in the morning to the Great Wall and explored before the queues gathered and the heat of the day. Again, local people just loved the experiences of the seasonal fruit markets and the fact that we hit a blue sky day.
We also went in the weekend to some shopping malls, including to see Mother and Baby stores and the placement of a2 infant milk formula. Our general observations on a busy weekend were strongly backed by our guide and driver, both of whom suspect that the message to see China first is resonating as the party atmosphere builds for the big 70th celebrations on the 1st of October.
In the evening of the weekend, we also witnessed the strange closure of central Beijing as the military practised their parade and celebrations for two weekends' time. The central city was locked down, including closing the blinds in restaurants overlooking the city centre. We understand it took about 3 hours for the full practice parade to pass by, so I assume the celebration will have all the bells and whistles. Local Beijing residents we talked to were very excited and happy to put up with the disruption.
Local articles also outlined new subways (to open up more affordable housing), fast trains and the soon-to-be-opened new international airport in the south of Beijing.
But what about the data?
Most economists agree that China cannot continue to grow sustainably by 6% per annum. It seems widely accepted that the challenges of an ageing population and a focus on the environment may slow growth in many sectors. It is also a concern that productivity growth continues to slow, and public sector leverage is unsustainably high.
Manufacturing business confidence is weak (sub 50), and consumer demand data has weakened, down from some strong readings in the first half of 2019. Despite policy aimed at higher infrastructure spending, actual data has only lifted a little, while other hard data has also been consistent with a mid-year meaningful slowdown.
Reading through all this, analysts suggest that the trade war has nipped investment growth and exports (albeit imports are also lower). The suggestion, however, is that the tariffs so far haven’t been the whole story on the slowdown and hence there is rising nervousness amongst business.
Since July, both monetary and fiscal policy has been eased significantly, with more announcements expected. The Renminbi has also fallen significantly (with most people saying that Beijing doesn’t want further weakness). Feedback from corporations is that measures to improve entrepreneurial spirit are needed and recent announcements about a collaboration among all three large telcos on the 5G rollout to 50 cities are part of the new approach to encourage certainty for some sectors.
Nevertheless, the message from business to Beijing seems to be that we need some certainty on trade one way or another. The Chinese view is that homegrown technology, AI and manufacturing will improve over time but, for now, China’s supply chain is integrated into Asia and America even for 5G with, for example, a reported shortage of chips.
To conclude, the economic data seem unlikely to improve in the next month or so, but policy announcements may continue to encourage sentiment about growth and the potential for some further structural reform. The removal of foreign investment restrictions last week is an example of medium-term policy change.
I had meetings with several companies including Huawei, financial services company Pin An, and the second-largest mobile operator, China Telecom. A high-level summary is that the level of research and development investment is astonishing, employee growth in AI, software as a service, platforms and 5G is very advanced. China has the advantage of global scale and an ecosystem that can move quickly to deploy at scale new technologies covering payment systems, driving, healthcare, consumer lending, wealth management and the Internet of Things.
My final observations as I left Beijing at Beijing South Railway Station (Beijingnan) were of the sheer size, efficiency, cleanliness and the use of technology. Being a holiday weekend, I had expected to queue for an hour to get an issued ticket, having booked overseas. In fact, the ticket office was small, with no queue and, like most modern transport hubs, local residents had mobile phone bookings and QR codes as if we were boarding a domestic flight in New Zealand.
My key observation was of happy people, saying goodbye to parents, maybe grandparents, lots of children, presents, suitcases, with nearly everyone on their mobile phones. No wonder they need 5G soon. Unsurprisingly the one book shop was empty.
What is the narrative about sustaining Chinese growth?
First, the environment in China has vastly improved. In both Shanghai and Beijing we experienced blue sky days.
Cleaner air, recycling, encouraging investment in lower CO2 emissions, active policies for adoption of EVs, compulsory EV motorcycles and the move to eliminate single-use plastics all add to a growing approach to changing behaviours and outcomes. The list of measures tackling the move to a more sustainable economy is large and the implementation of the policy is palpable.
Generally speaking, most economists say that GDP growth in the 5%-6% band is enough for full employment in China in the coming year. China is also not expected to deliver a stimulus that assists global growth; it’s all about local requirements consistent with other strategic goals.
We have about 15 months to run in the current five-year plan and it seems likely that infrastructure spending will be lifted in the near term so the 2019 year finishes with strength. However, commentators were divided on the implications for iron ore and steel demand, given the global weakness in manufacturing.
There is no desire for big consumption and leveraged monetary or fiscal stimulus. Public debt is already high, and the efficacy of tax or monetary stimulus is questioned, especially given consumers have a high propensity to save.
Instead, the feedback is that policy is likely to focus on real reforms in rural development and land reform, healthcare, pensions and insurance, and continuing to deploy technology, especially 5G, and the Internet of Things.
Broadly speaking, China has a long path ahead in urbanisation, despite already having more than 50 cities with over 2 million people.
An urbanisation rate of 1% per annum needs to be associated with creating about 5 million jobs each year. Additionally, university graduates number about 9 million new workforce entrants. This means that economic growth has to be about 5% pa to create some 14 million jobs and, increasingly, these jobs need to be in higher-paid industries. Full employment is possibly the highest goal of the Communist Party.
We witnessed many companies with opportunities to introduce robotics who provided anecdotes about the easier path to employ labour. The agenda on employment and investment in robotics seems to differ depending on the region and city.
Allied with full employment objectives are goals around the environment, anti-corruption and security.
In terms of macro-economics, today interest rates are about 4.3-4.4% in China, and the official Reserve Ratio Requirement is 13%.
Both policy tools could be used to spur growth, albeit there are risks in terms of weakening the renminbi further and creating excessive liquidity when public and state-owned enterprise debt is already high. On balance, a wait and see monetary policy stance is expected. Analysts think that there will be some patience to wait for the trade talks to come to some point and see whether the economy responds to recent easier policy positions. There is no sense of panic among commentators, hence the phrase do not expect a sugar rush that fires up the global economy.
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