By ROBERT HARLEY 13/10/2006
If you’ve been watching the ITV News focus on China this week you will have picked up a fascinating insight into this rapidly changing country. However, while the growth potential is obvious, does China make sense for UK investors?
On the surface there seems little reason to think otherwise. China’s meteoric economic growth, as shown in the chart below, has catapulted it into the fourth largest economy in the world (after US, Japan and Germany). Importantly, the rate of annual GDP growth has also been quite stable at around 8-10% for the last 15 years and many economists predict this could be maintained for a further 15 years.
There is also massive potential for growth in domestic demand thanks to a population of 1.3 billion, over one fifth of the World’s total. The Chinese are embracing consumerism and this will undoubtedly grow although it’s important to remember that, despite high economic growth, China’s GDP per head is still just $1,500 (compared to $40,000 in the UK) hence spending is still very low by Western standards. Nonetheless, domestic demand could prove a saving grace for China if, as some predict, continued Central Bank interest rate rises around the World cause a global slowdown hitting Chinese exports.
| "One of the keys to domestic growth is China distributing its wealth more evenly." |
One of the keys to domestic growth is China distributing its wealth more evenly, as at present it is concentrated on the Eastern Coast. The Chinese Government is trying to address this by introducing tax-free development zones which, if successful, will benefit not only wealth distribution but also infrastructure and logistics companies. Growth in the farming sector will also help and the outlook is promising following the Government granting farmers rights of tenure on their land, giving greater incentive for farmers to invest in and develop their land.
Perhaps the most hotly tipped area is financial services: credit cards barely exist while savings accounts and mortgages remain the preserve of a few. For example, when a Chinese consumer buys a good or service online (increasingly popular) it is typically paid for cash on delivery – the scope for credit cards and online payment systems is almost unfathomable. Healthcare is not far behind as spending in this area has lagged economic growth and will almost certainly have to catch up in future.
While it hard to envisage China falling over long term, there’s plenty that could cause tears along the way. Despite going through rehab, China’s banks are still far from healthy due to the threat posed by bad debts. Chances are they’ll shrug these off and eventually prosper, but it may not be an easy ride. Currency revaluation (expected to continue at 4-5% a year against the US$) could hit exports, although if the previous experience of Japan and Taiwan are anything to go by the broader market could rally in spite of the loss of competitiveness. Given China’s big advantage on the World manufacturing stage is low labour costs, wage inflation, currently 13-15%, is also important. It may be that increased automation and efficiency can offset this medium term, but it is still a very real threat.
| "We should not forget the potential for hiccups arising from the legacies of the communist order." |
We should also not forget the potential for hiccups arising from the legacies of the communist order: question marks over property rights, corruption, internal political pressures, under investment in public services, energy shortages and an inefficient fiscal system.
In summary, it is conceivable that Greater China can establish itself as a fourth mainstream equity asset allocation decision, to be considered alongside the US, Pan European and Japanese equity markets. However, this may be 10-20 years away and the potential path to riches will almost certainly be a volatile one. We suggest keeping exposure to China at no more than 3% of your equity portfolio, investing for at least 7-10 years and avoiding panic decisions when the next crisis emerges.
Although several China specific funds are available, a more practical alternative could be to invest in an Asia Pacific fund with Chinese exposure. Also bear in mind that many managers prefer to play China by buying Chinese companies quoted in Hong Kong (‘H’ shares) and investing in Taiwanese companies which stand to benefit from China’s growth, especially as local China stockmarket performance has been poor. Some Western and Japanese companies are highly dependent on China’s prospects too, offering yet another option for playing the Chinese market. You can view a list of rated funds here.