In 2005, PortfolioConstruction Forum's publisher, Graham Rich, and Think Global Consulting created the Think Global BRIC Study Tours – highly tailored, week-long study programs, designed to give participants vital on-the-ground exposure and materially increase their understanding of each BRIC market and its role in portfolio construction.
The first BRIC Study Tour was to China in April 2006. I attended the second Study Tour in October 2006. You learn a vast amount on the week-long Tour. Here are my key takeouts from Day 1...
Monday, we were up early to travel by bus to our venue for the day, a restored Chinese building in the old French concession (finally, something that looked like we were in China), for a day of briefings about China's economy, business environment and social structure by those who live and work there. We had an incredible caliber of speaker :
Christopher Wright, Austrade Shanghai's senior trade commissioner, on China's economy past, present and future;
Clinton Dines, head of BHP Billiton China, on The BHP story in China (Chatham house rules prevailed for this session);
Richard Williamson, Commonwealth Bank's general manager of Asia strategy, on China's financial services sector; and
Wang Yong, assistant editor-in-chief of Shanghai Daily, on how the Chinese live.
Everything is big...
The first thing everyone tells you about China, once they realise you're new to it, is that it's BIG, that you'll find it impossible to get your mind around the numbers.
There are 1.4 billion people, including 700-800 peasants. This became a running Tour joke – every speaker during the week gave us an estimate of the number of peasants, but each was different. In the words of one Tour member "is it 600 million, 700 million, 800 million, 900 million – oh never mind, what's a few hundred million people either way?"
And what exactly is a peasant? In China, any farmer is a peasant. Yes, for the most part, they're poor, but even the wealthy ones are called "peasants".
But back to the numbers... 14 million engineers, 600 cities (33 are home to over 2 million people). Over 35,000 kilometers of highway has been laid in the last 10 years, and another 85,000 will be laid in the next 30 years, all part of China's Expressway Network Plan to connect all cities with populations of greater than 200,000.
I heard this at the start of the week-long Tour, and I didn't really believe it. But I did by the end of the week. One of the key lessons I took away with me from the Tour is that China thinks long term. It has a 30-year plan for every important facet of the economy. As one speaker put it: "Western governments plan to the next general election. China's officials plan for the next 30 years - which is possible because there are no elections." These 30-year plans are not just words on paper. They get implemented, on schedule.
Such a vast amount of concrete - 35,000 kilometers - had me wondering whether there would be any green left in China once it was all poured. The consensus across all the week's presenters was that the environment is a very real concern to the Chinese government, albeit that it only recently became so. As with anything it turns its mind to, there is a robust plan to reduce environmental damage.
Back to the big numbers...
Each year, China brings on "a UK and a bt" of power, we were told. Some 70% of China's power is currently coal generated, complimented by gas and hydro. In the next decade, coal generation is expected to account for 60% (on a growing base, keeping in mind the rate of urbanisation) with natural gas and nuclear energy (32 plants!) picking up the slack. Incredibly, it's not possible for China to concentrate all its energy in just coal, gas or nuclear plants, because it would exhaust the worldwide supply of the raw ingredients! So in the next decade, China will bring on more energy in each area – water, nuclear, wind, gas, coal, etc – than the rest of the world combined.
One number that’s not big is the number of lawyers (some would say this is not a bad thing) – just 120,000 for a country of 1.4 billion people. "The legal system has good architecture but poor implementation," one speaker opined.
And of course, the economic numbers are big...
GDP has grown at 8% to 10% per annum on average through the 1990s and 2000s.
Exports are growing at 25% to 35% per annum. There was a lot of discussion around this amongst Tour delegates, particularly the threat posed if the US economy came off the boil. However, as one speaker noted, China's exports are well diversified and what is exported is low value - and, if the US economy slows, the US consumer will still shop at the low value end of town.
Another natural question was how much of the GDP growth is dependent on foreign investment. One speaker noted that domestic demand is such that if all foreign investment pulled out, China’s GDP would fall by only about 1% per annum.
Another question that came up again and again was "is growth sustainable?" Not one person we spoke with during our week doubted that it was (and they weren't all bulls, some were very bearish about other issues). One presenter recommended that we think of China not as an Asian tiger, but in the same light as the US in the 1880s and 1950s – going through massive economic revolution fuelled by industrialisation, urbanisation, and the emergence of a middle class.
The urban/rural divide
There was a lot of focus on the urban/rural wealth inequity. Austrade's Christopher Wright put up an interesting chart, showing the gap is closing slowly. Following 74,000 protests by the people in 2004, the gap halved in 2005 – not by halving anyone's income, rather than as a result of urbanisation. This was a shock – I'd thought protesting in China was a one way street to prison. But apparently, protests are very common. It's the topic that's the issue – economic protest is allowed. Political freedom, choice, elections, human rights remain strict no go areas.
As expected, the Central Party has a 30-year plan to reduce this urban/rural divide. In 2004, 80% of households were "poor", defined as earning less than 25,000 yuan per annum. This is about $A4,166. Only 10% of households are currently "upper middle class", earning 40,000 to 100,000 yuan per annum ($A6,666 to A$16,666). By 2025, poor households are expected to be just 10%, with the upper middle class at 60% and lower middle class at 20% The mass affluent (earning greater than 100,000 yuan) will be just under 10%.
Another myth busted
Another myth dispelled during our first day was that China is only a manufacturing success story. There is a growing services sector. The financial services market is growing twice as fast as the rest of the world, and by 2020, will be larger than Germany's. China is already the world's largest consumer of international education, and the world's largest telecommunications market. By 2020, it is expected to be the world's largest tourism destination, and the fourth largest source of tourists.
In the afternoon, Richard Williamson gave a detailed overview of the financial services market. Once again, the numbers were huge. China's banking assets in $Abn are over four times the size of Australia's and only marginally behind those of the UK. The banking industry is critically important – banking assets form 77% of the country's financial assets, and the industry has undergone rapid reform in the past several years. (For a detailed description of China's financial market reform refer to "Gugai and other reforms" in the Summer 2006/07 PortfolioConstruction Journal Click HERE >)
Interest rates are low, as a way of subsidising Chinese corporations, however retail mortgages are still very profitable at around 400 basis points compared to 100 basis points in Australia.
The problem, Williamson explained, is that the Chinese pay off their mortgages too quickly – in around three to five years! They do this by saving more than 50% of their salary.
Internet banking has not yet taken off, as the infrastructure is not yet robust enough to support it.
There are four distinct tiers of bank: the big 4 state owned banks; 12 joint stock banks; 111 City Commercial Banks; and 39,000 credit co-ops (38,000 of which are rural based). That's 40,000 banks in total, an impossible task to regulate. It's a market ripe for consolidation, encouraged by the government which fears social unrest in the event of bank failures. Estimates are the number of banks will fall to around 2,000 in the next decade.
The credit card market is small at just $US700 million, but this is growing at such a rate that China was the fourth largest credit card market in non-Japan Asia in 2006.
Share market capitalisation is only just behind Australia. Total debt securities are 50% higher than Australia, and about half of the UK.
However, the life insurance and funds industry is fledgling. At around $A180bn, it is well down on Australia ($A1000bn). The current environment is dominated by local players. The top five fund managers are all local and relatively young, having started in 1998/99. These five control over 45% of FUM, but between them offer just 47 funds. While the industry experienced strong growth between 1999 and 2001, Chinese investors tried to stag early fund IPOs, causing FUM to halve very early on. As a result, since 2002, fund managers have stopped offering closed-end funds.
It's expected that the Chinese fund market will grow with the development of a healthy internal stock market, something that is a key priority for the government. Since 2005, commercial banks have been allowed to set up funds management entities, and the regulator has recently approved the establishment of the first fund distribution company, which will only provide advisory and sales services to investors. The regulator has also begun to allow qualified domestic institutions to invest overseas markets, enabling greater diversity of fund offerings.
We were amazed and delighted to hear that "tax is almost voluntary" in China. Private tax collection is around 2%, and while the corporate tax rate is 30%, it drops considerably to 15% if you set up business in a special economic zone such as Pu Dong (an area across the river bank in Shanghai). And, we heard, corporate tax is totally negotiable for local companies!
Of course, by now, we were all considering moving to China.
Not all rosy
It was left to our last presenter of the day to bring us back down to earth. Wang Yong is assistant editor-in-chief of the Shanghai Daily. He opened by explaining that he wanted to show us "the other China".
His numbers were also big. He estimated there are 900 million peasants at present. Six million migrate to the cities every year for jobs, and over 40 million have left the land in the last ten years. In the next five years, a further 15 million will move to the cities.
However, there are not enough cities to absorb the flow, and as fast as housing and other infrastructure is being built, it is not fast enough to keep pace.
Until recently, the environment has been neglected in favour of fast development. The land is very dry in many parts, with drought caused by land clearings and diversion of rivers. What water remains is often tainted – some 70% of lakes and rivers are seriously polluted with the resulting loss of bird life, and 400 million people do not have access to clean water. The Yangtse, which ten years ago was very clean, is now green and at the current rate will be ruined within ten years. Many trees near rivers have been chopped down by the peasants to earn money to live, exacerbating the drought conditions and pollution (the government has responded by paying the peasants to protect the trees).
And so our first day in China came to a close, after eight hours of presentation, discussion and debate.
The rest of our week was similarly jam packed. It included a visit to a property investment house and property developments. We beat a retreat to the Great Wall (nothing can prepare you for the sight, after a few hours on the bus, of the Great Wall on the top of nearby hills). We traveled there with Professor Xisu Wang as our special guest lecturer. We had some very interesting debates about Chinese society, politics and history, no topic was off limits.
Then, it was back to Beijing for further briefings by investment professionals on the opportunities and challenges of investing in the China story. We visited Ikea's main store in China to hear the challenges of being a western business in China - where we saw the unusual sight of a highway running out mid-air - and attended an awards dinner for China's logistics industry, one of if not the key industry in China. We met the man who wrote the most recent five year plan for the entire logistics industry. He reports directly to President Hu Jintao, but he was very keen to meet us "big noses".
It's impossible to describe how your knowledge of China increases exponentially during a week long BRIC Study Tour. You realise you've learned a vast amount, but really only scratched the surface.
Am I convinced of the strength of China as an investment story? I think so, at least for the next 20 years while the Chinese people are focused on working hard to increase their wealth and their wealth continues to improve.
Yes, there will be stresses and strains on the system in the meantime, and bumps along the investment path. But ignoring China in constructing portfolios would be madness. How you access that investment story is the key challenge – but that’s a topic for another day.
Deirdre Keown is the Managing Editor of PortfolioConstruction Forum
Construction Forum, Brillient Investment Publishing Pty Ltd ABN 19 122
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