Invesco Global Insights Global Investors’ Forum – China The Investors’ Forum brings together Invesco’s investment professionals from around the world to discuss issues that are critical to global investors.
Investing in the beneficiaries of China’s new growth drivers Invesco’s Global Investors’ Forum held the first in a series of discussions on China. Investment professionals from around the globe engaged in an interactive discussion with their colleagues. Stuart Parks and William Yuen started the discussion by sharing their views on the latest macro– economic trends in China and the implications for investors. The conversation was then opened up to their fellow investors for a Q&A. Close to 100 investors across the firm called in to participate. Contributors
Tell us about China’s growth prospects. What should investors expect? Unlike many major developed markets in the world, China’s growth prospects across its regions are actually very different. If you tally up the top five or 10 provinces, they only represent a small percentage of the overall GDP of China. – W. Yuen
Stuart Parks Invesco Perpetual
As seen in figure 1, the official China GDP for the first quarter of 2016 was 6.7%. However, the shaded provinces, such as Liaoning and Shanxi, are growing at much lower rates. In fact, some of them have registered negative GDP growth. Conversely, more prosperous regions like Jiangsu, the Pearl River Delta and certain Western China provinces have outpaced the official GDP rate. Given the scale of China’s market, each region must be examined separately to fully understand it. – W. Yuen Figure 1: China’s growth prospects are different across regions Western
Northeastern
Central
Below overall GDP growth
Eastern HEILONGJIANG 5.1% Rmb1,508bn
William Yuen Invesco Asia Pacific The document is intended only for Professional Clients in Continental Europe, Dubai, Ireland, the Isle of Man, Jersey and Guernsey, and the U.K;. for Qualified Investors in Switzerland; for Institutional Investors in Australia and the U.S.; for Professional Investors only in Hong Kong; for Qualified Institutional Investors in Japan; for Institutional/Accredited Investors in Singapore; for certain specific Qualified Institutions/Sophisticated Investors only in Taiwan; for Persons who are not members of the public (as defined in the Securities Act) in New Zealand. The document is intended only for accredited investors as defined under National Instrument 45-106 in Canada. The document is for one-to-one institutional investors only in Chile, Panama or Peru. It is not intended for and should not be distributed to, or relied upon by, the public or retail investors.
JILIN 6.2% Rmb1,427bn
XINJIANG 6.9% Rmb932bn
LIAONING -1.3% Rmb2,874bn
INNER MONGOLIA 7.2% Rmb1,803bn
GANSU 7.3% Rmb679bn
SHANXI 2.5% Rmb1,280bn
NINGXIA 6.9% Rmb291bn
QINGHAI 8.3% Rmb242bn
HEBEI 6.5% Rmb2,981bn
TIBET 10.7% Rmb103bn
Q1 2016 China overall GDP growth: 6.7% Nominal GDP: Rmb67.7 trillion (2015)
GUIZHOU 10.3% Rmb1,050bn YUNNAN 6.6% Rmb1,372bn
Province Year-over-year Q1 GDP growth (%) Nominal GDP in Rmb billions (2015)
SHANDONG 7.3% Rmb6,300bn
HUBEI 8.1% Rmb2,955bn
SICHUAN 7.4% Rmb3,010bn
TIANJIN 9.1% Rmb1,654bn
JIANGSU 8.3% Rmb7,012bn
HENAN 8.2% Rmb3,701bn
SHAANXI 7.6% Rmb1,817bn
HUNAN 7.3% Rmb2,905bn
GUANGXI 7.0% Rmb1,680bn
BEIJING 6.9% Rmb2,297bn
ANHUI 8.6% Rmb2,201bn
JIANGXI 9.1% Rmb1,672bn
ZHEJIANG 7.2% Rmb4,289bn
SHANGHAI 6.7% Rmb2,496bn CHONGQING 10.7% Rmb1,572bn
FUJIAN 8.3% Rmb2,598bn
GUANGDONG 7.3% Rmb7,281bn Hong Kong
HAINAN 9.7% Rmb370bn
Sources: CEIC, Morgan Stanley Research, NBS and Bloomberg L.P., May 2016. This white paper was generated in conjunction with Invesco’s Global Investors’ Forum, based on research conducted by Invesco’s U.S. Product & Market Research group. The Global Investors’ Forum brings together each of Invesco’s 750-plus investment professionals from around the world to discuss issues that are critical to global investors.
1
Should investors be concerned about the level of debt? As a starter, much of the growth that we have seen over the past decade has been fuelled by a buildup of debt. It’s obviously difficult to be precise about the debt-to-GDP ratio in China. Most commentators assume an approximate figure of 250%. Difficulty arises due to the rapid growth of the so-called shadow banking system which is extremely difficult to measure. – S. Parks The rise of debt to GDP from about 150% in 2008 to close to 250% in 2015 is not sustainable. However, much of it was due to the stimulus package China introduced following the global financial crisis which went into excess-capacity industries. – W. Yuen This is the sort of level at which other countries have seen their debt levels toppling over, leading to a collapse in growth. As such, history would say that at some point in the future there might be problems. Unsurprisingly, markets are concerned. – S. Parks Figure 2: China’s rising debt levels are concerning investors Total debt as % of GDP 300 250 182
101
114 122
149
161 155 156 155 154 154
2003
150
135 138
2002
200
197 196
211
198
220 215 220
230
249
263
274
100
2017E
2016E
2015
2014
2013
3Q13
1H13
1Q13
2012
2011
2010
2009
2008
2007
2006
2005
2004
2001
2000
1999
1998
1997
50
Source: Goldman Sachs, as at May 18, 2016. Note: E = estimates.
Tell us how China’s debt compares to debt levels in other emerging and developed markets. Are there important differences investors should consider? Figure 3 shows you that China’s debt is actually very different from the mix in other G20 countries. Clearly, China’s overall debt level is not the highest at this moment. Looking at the numbers in detail, we see that consumer debt comprises about 40% of the mix. – W. Yuen The problem area is non-financial corporate debt, which is at about 170%. This is concerning and is mostly coming from lending related to SOEs (state-owned enterprises) that has gone bad in excesscapacity industries. Furthermore, when you look at the government’s debt level, it’s at about 45% which already includes local government debt. In short, when you look at the breakdown of China’s debt, you will see that it is very different to the mix in developed markets and other emerging markets that led to the 2008-09 financial crisis. – W. Yuen
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Figure 3: China’s debt mix is different from other economies Household Japan France Canada Italy U.K. China U.S. Australia South Korea Germany Brazil India South Africa Turkey Russia Mexico Argentina Saudi Arabia Indonesia
Non-financial corporate 66
Government
101
57
221
125
109
98
112
43 87
73
79
105
266 44
71
73
37
17
35
59
17
25
36
7 14 48 23
0
126 113
93
77
53
14
235
184
129
53
57
244
148
68
37
40
78
50 51
21
37
106 53
26
251
82
88
10
255
100
124
17
275
171
54
288
154
40
16
78
79
388 290
74 6 68
27
67
50
100
150
200
250
300
350
400
Credit to GDP ratio, 2015 (%) Sources: Haver, Bank of International Settlements and Citi Research, June 2016.
Another important issue is that so much of this debt has actually been directed into areas of the economy that produce very low returns and, in some cases, even immaterial returns. – S. Parks A lot of debt went into inefficient, low-productivity industries like steel and coal, and part of the property sector as well. What that means is that they have been investing a lot of money through debt into excess-capacity industries which is raising concern and putting pressure on the banking sector as a whole. – W. Yuen
How efficient is the allocation of capital? What implications does this have for China’s economy? Figure 4 shows China’s incremental capital-output ratio (ICOR) between 2000 and 2015. ICOR is a fairly simplified way of measuring just how many units of capital you need to produce a unit of economic growth. As you can see, in the boom years of China in the early 2000s after its entry into the World Trade Organization, China was a highly productive place. – S. Parks As we have exited the global financial crisis, while more and more capital has been used to promote infrastructure growth in China, the ICOR has risen, and as a result, we are getting high levels of debt which are not being used productively. – S. Parks Figure 4: A higher ICOR ratio suggests a less-efficient use of capital China: Incremental capital-output ratio (ICOR) 8 7 6 5 4 3 2 1 2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Source: Datastream, as at June 22, 2016. Note: ICOR is incremental capital divided by incremental real GDP. Invesco Global Insights3
What we need in China is for the allocation of capital methodology to change. We need more capital to go into the private sector, which, in general, is a highly efficient utilizer of capital when it’s available, and less into the SOEs. There are signs of improvement already in this area, but I would say that a lot more needs to be done. – S. Parks
We’ve heard a lot recently about overcapacity in state-owned enterprises (SOEs). Is this something investors should be paying attention to? One thing we have noticed is that the government has been very proactive in trying to scrutinize the effectiveness and productivity of some of the industries. While it takes time to reduce overall capacity, in the past 12 to 24 months, we have seen shutdowns in industries such as steel and coal because of the excess-supply issues that led to low global commodity prices in some of those sectors. – W. Yuen Further, with respect to the overall debt situation, if you recall, the consumer debt in China is relatively low at about 40%. In my view, the government is trying to promote and leverage up the consumer sector while stabilizing the corporate sector. That’s something we are monitoring quite closely, and we have seen some progress on that. – W. Yuen Similarly, I’d like to stress that there has been genuine progress. In actual fact, some of the shutdowns have been deeply meaningful already in steel, coal and cement. – S. Parks
What do you think the most attractive opportunities are for investors today? Where should they be looking? Why do we still believe there are opportunities? The first thing to say is that we don’t see collapse as imminent. Foreign-exchange reserves are still plentiful, and the restrictions on the capital account are working. Also, the loan-deposit ratio of the banking system is probably still less than 100, and that means that the banking system is liquid. It is still able to support the debt that has been built up. – S. Parks From our own investment perspective, very similar to Stuart’s, we are largely focusing on the private enterprises, which are earning very high ROE, are privately and competitively run, and have very good margins, management, etc. – W. Yuen
A lot of investors are interested in the property market. How healthy do you think this market is in China today? With respect to the property market and potential oversupply, figure 5 shows that there are early signs of recovery. The top-tier cities are progressing well, but we believe the excess inventory problem in lower-tier cities is unlikely to be resolved and is one of the concerns relating to problem debts in China. – W. Yuen
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Figure 5: Property inventory vs. investment cycles 35-city inventory/sales ratio (months, lhs)
Year-over-year nationwide real estate investment (%, rhs)
22 20
40
20.4m
19.7m
18 16
Average 14 months
Average 17.5%
14
17.5
12 10
2017
2016
2015
2014
2013
2012
6
2011
8 -5
Sources: CEIC and Citi Research, June 2016. Note: 35 major cities include four first-tier cities, 20 second-tier cities and 11 third-tier cities. The four first-tier cities are Beijing, Shanghai, Guangzhou and Shenzhen; the 20 second-tier cities are Changchun, Shenyang, Tianjin, Taiyuan, Jinan, Qingdao, Nanjing, Suzhou, Hangzhou, Ningbo, Hefei, Nanchang, Changsha, Fuzhou, Xiamen, Guiyang, Nanning, Xi’an, Nanzhou and Xining; and the 11 third-tier cities are Huainan, Maanshen, Jining, Yantai, Changzhou, Nantong, Wenzhou, Jiujiang, Jingmen, Maoming and Beihai.
Where should we expect the bulk of growth to come from going forward? What do you see as the primary drivers? Where we are actually looking and investing is where we are seeing the beneficiaries of the new growth drivers of China, namely relating to the services front. Whether it’s internet, health care, consumer services, etc., they seem to be growing very rapidly. If you’re talking to and looking at these so-called industries (mostly in services) riding on the younger generations of China, the situation looks promising. If you’re looking at the more traditional industries, though, that’s a lot more bleak. – W. Yuen It’s important to track the breakdown of GDP growth going forward. Right now, the services component is already more than 50% of GDP. As long as you see that number continue to rise and the secondary and primary industries come down, it suggests that rebalancing of the economy is happening. – W. Yuen Wage growth has been propelling the consumer sector which continues to be the major determinant of where growth in China is going to be in the future. If wage growth slows and becomes negative in real terms, then I think that is the time we should really worry. At the moment, wages are still growing, and the economy itself is still growing, if not as quickly as it once was. – S. Parks Obviously there are areas where wage growth has stopped, and I think over time the introduction of automation is something that needs to be watched very closely in this context. There are large sections of the Chinese workforce that are potentially subject to dislocation as a result of increased automation. – S. Parks
Investors are intrigued by the opportunity of a more open market. Understandably, though, some are concerned the trend may not continue. Do you think the government will continue its commitment to more open markets? I think China’s government is rather pragmatic about all of this and that they would like to open up more. They have seen that opening up too quickly, though, especially in times of high volatility, can lead to quite a lot of foreign-exchange outflow which is problematic when there’s a banking system that needs liquidity. – S. Parks China’s domestic financial markets and currency are still largely functioning in a closed system (mainly via capital control). We cannot expect them to open up overnight. However, if you look at more recent news and activities, China is trying to liberalize and internationalize itself. One such example is to encourage greater outbound investments. With internationalization, China is also expecting the reverse to happen – namely, attracting new capital flows to China. It should work both ways. – W. Yuen Invesco Global Insights5
Important information The document is intended only for Professional Clients in Continental Europe, Dubai, Ireland, the Isle of Man, Jersey and Guernsey, and the U.K;. for Qualified Investors in Switzerland; for Institutional Investors in Australia and the U.S.; for Professional Investors only in Hong Kong; for Qualified Institutional Investors in Japan; for Institutional/Accredited Investors in Singapore; for certain specific Qualified Institutions/Sophisticated Investors only in Taiwan; for Persons who are not members of the public (as defined in the Securities Act) in New Zealand. The document is intended only for accredited investors as defined under National Instrument 45-106 in Canada. The document is for one-to-one institutional investors only in Chile, Panama or Peru. It is not intended for and should not be distributed to, or relied upon by, the public or retail investors. This overview contains general information only and does not take into account individual objectives, taxation position or financial needs. Nor does this constitute a recommendation of the suitability of any investment strategy for a particular investor. It is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any trading strategy to any person in any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it would be unlawful to market such an offer or solicitation. It does not form part of any prospectus. While great care has been taken to ensure that the information contained herein is accurate, no responsibility can be accepted for any errors, mistakes or omissions or for any action taken in reliance thereon. The opinions expressed are those of Stuart Parks and William Yuen may differ from the opinions of other Invesco investment professionals. Opinions are based upon current market conditions, and are subject to change without notice. Past performance is no guarantee of future results. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Asset management services are provided by Invesco in accordance with appropriate local legislation and regulations. This material may contain statements that are not purely historical in nature but are “forward-looking statements.” These include, among other things, projections, forecasts, estimates of income, yield or return or future performance targets. These forward-looking statements are based upon certain assumptions, some of which are described herein. Actual events are difficult to predict and may substantially differ from those assumed. All forward-looking statements included herein are based on information available on the date hereof and Invesco assumes no duty to update any forward-looking statement. There can be no assurance that estimated returns or projections can be realized, that forward-looking statements will materialize or that actual returns or results will not be materially lower than those presented. Note that strategies mentioned may not be available to all investors or in all jurisdictions. Please contact your local Invesco representative for more information. All information is sourced from Invesco, unless otherwise stated. All data is as at May 13, 2016, unless otherwise stated. All data is in U.S. dollars, unless otherwise stated.
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* Invesco® and all associated trademarks are trademarks of Invesco Holding Company Limited, used under licence. © Invesco Canada Ltd., 2016 Published September 20, 2016 GL303
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