China’s New GrowthNew Growth

Model

Arthur Kroeber February 2013

China is still growin

1. GDP growth will average 7% in 201

2. Structural reforms are necessary fodeliver enough despite political op

3 Th h d i i l d hif i3. The growth driver is already shiftin

4 D d f i t t i i f t4. Demand for investment in infrastrustrong and will be a key swing facto

5. Financial liberalization is moving faaccount opening is constrained byaccount opening is constrained by

ng – but differently

12-20, down from 11% in 2002-11

or that level of growth; new leaders will position and debt constraints

f i ig from investment to consumption

t h i d l t i tillucture, housing and new plant is still or

aster than many realize, but capital financial repression elsewherefinancial repression elsewhere

2

1. Trend growth is slo

• At 20% of US per capita GDP

enjoy another decade of fast c

d l f J K d T imodel of Japan, Korea and Tai

P t ti l th i• Potential growth is now arou

the past decade, and volatilityp y

• Yet thanks to the high base eg

will continue to grow rapidly

owing, but still solid

P (at PPP), China still can still

catch-up growth on the

iiwan

d 7 8% d f 11% iund 7-8%, down from 11% in

y will risey

effect, China’s global impact g p

3

Catch-up growth still haas a long way to run…

4

…but the potential GDP growth rate is now lower…

5

…yet slower growth does not mmean China gets less important

6

The low volatility of 20001-07 will not return

7

2. Policy shifts from cyclical ma

• Government’s ability to smoot

d i i i d band investment is constrained b

ratios

• Achieving potential growth re

capital allocation:

o Financial liberalization (highe( g

o Competition (curtai

o Fiscal (improo Fiscal (impro

o Factor prices (energ

• New leaders will pursue reform• New leaders will pursue reform

incrementally

anagement to structural reform

th cycles by pumping up credit

b hi h i d d bby high investment and debt

quires reforms to improve

er return on investment))

il SOEs and local protectionism)

ove local govt incentives)ove local govt incentives)

gy, water, land)

m but cautiously andm, but cautiously and

8

The downturn in China was nnearly as severe as in 2008…

9

…yet the policy respoonse was much weaker

10

Politics does not explain whyy China was slow to stimulate

11

The real constraint: Debbt levels are now higher

12

Another constraint: Tight job markeet means more inflationary pressure

13

New leaders: cauChina’s ne

The Politburo Standing Committe

Protocol BirthProtocol

rankName

Birth

yearNew jo

1 Xi Jinping 1953 Presidp g

2 Li Keqiang 1955 Premie

3 Zh D ji 1946 NPC C3 Zhang Dejiang 1946 NPC C

4 Yu Zhengsheng 1945 CPPCC

5 Liu Yunshan 1947 Vice P

6 Wang Qishan 1948 Discip

7 Zhang Gaoli 1946 Execut

* Not yet official as government positions will be ann Not yet official as government positions will be ann

utious reformersew guardee of the 18th Central Committee

ob* Old job

ent Vice President

er Executive Vice Premier

Ch i Ch iChairman Chongqing

C Chairman Shanghai chief

resident Propaganda chief

pline chief Vice Premier

tive Vice Premier Tianjin chief

nounced in March 2013nounced in March 2013.

Xinhua, GK Dragonomics research

14

3. ‘Rebalancing’ to more cons

• After rising steadily from 199

ratio fell slightly in 2011 and 2

• By the end of the decade rea

th ld b l 3 5growth could be as low as 3-5

growing nearly double thatg g y

• Growth in high-value consumg

strong due to the ‘acceleration

sumption has already begun

98 onward, investment/GDP

2012

al investment spending

5% ith ti5%, with consumption

mption could be extremely p y

n phenomenon’

15

Diminishing returns fromm a high investment rate

16

Investment growth haas slowed permanently

17

External imbalances are much less severe

18

How low could inve

Average real AveragePeriod

Average real growth in

investment

Averagegrowth inconsump

1996-2000 8.8% 8.9%

2001-2005 14.6% 8.6%

2006-2010 16.4% 11.1%

2011-2015e 6.5% 10.4%

2016-2020e 3.2% 9.8%

estment growth go?

e real Investmente real n final ption

Average real GDP growth

Investment ratio at end of

period

% 8.6% 34%

% 9.8% 40%

% 11.2% 46%

% 7.8% 44%

% 6.7% 39%

19

‘Acceleration’ means fast growwth in high-value consumption

20

Income inequality means a ffat tail of affluent consumers

21

4. Investment deman

• China’s capital stock per cap

large-scale investments in inf

i d t i l l t j tifi blindustrial plant are justifiable

C t t l b li f C• Contrary to popular belief C

already reasonably efficienty y

• Housing construction is abog

nd is not going away

pita is still a bit low; further

frastructure , housing and

hi ’ it l ll ti ihina’s capital allocation is

ut to plateau at a high levelp g

22

No capital misallocation: Returns in industry rise as state role shrinks

23

No capital misallocation: Low-retuurn industries get less investment

24

A chronic houssing shortageWe estimate China’s urban housing stock to comprise around 170-180m units of independent housing (those with their own kitchen and bathroom) by 2012.

This is significantly less than the total number of urban households. The remaininghouseholds. The remaining “under-housed” population is mostly migrant workers whose living quarters do not meet the definition of independent housing.

Th t l d b tThe government-led boost in the construction of low-cost housing since 2009 will help gradually address thishelp gradually address this shortage.

25

Housing construct

Policy will determine which patSupply of completed housing versus sou

12

14

8

10

6

8

mill

ion

2

4

02001 2003 2005 2007 2009 2011

New urban households Replacement

tion nears its peak

th China's housing supply takesurces of demand, in units and households

Scenario

Baseline

2013 2015 2017 2019 2021 2023 2025

t of existing housing Housing completions

CEIC, GaveKal Data

26

Outside the coast, hous

40

The most u

35

san

d

30

e, R

MB

tho

us

GuangzhouSuzhou

Nanjing

Xiamen

25

osa

ble

inco

me

Tianjin

Wenzj g

15

20

seh

old

dis

po

Taiyuan

100 250 500 750 1

Ho

us

0 250 500 750 1Average 100sq

ing is reasonably priced

unaffordable cities

Shanghai

Beijing

Shenzheng

Hangzhou

j gzhou

East South Central

Sanya

1 000 1 250 1 500 1 750 2 000

North Southwest

Northwest Northeast

1,000 1,250 1,500 1,750 2,000qm house price, RMB thousand

CEIC, NBS

27

5. Financial liberalizat

• Interest rates started to libermanagement products’ and sh

• Private sector access to capit

O t tf li i fl• Openness to portfolio inflow

• RMB is being adopted as a tr• RMB is being adopted as a tr

• But financial reforms are maBut financial reforms are maaccount can’t be fully openedmanipulating exchange and i

tion is well under way

ralize in 2010 through ‘wealth hadow banking

tal is rapidly improving

h d ti ll i dws has dramatically increased

rading currencyrading currency

inly domestic: the capitalinly domestic: the capital d while the US/EU/Japan are

nterest rates

28

De facto interest rate libberalization is advancing

29

Lending: Morre bottom up

30

Investment: LLess top down

31

A switch to promoting rather thhan restricting portfolio capital

32

A more international currency

33

Summ

1. China has begun a t‘ i l bili i‘capital mobilizationefficiency’ phase of gefficiency phase of g

2. A relatively smooth t. e at e y s oot tstructural reforms toleaders are cautious

3 Th lik l3. The most likely outcmore sustainable gromore sustainable gro

mary

ransition from the ’ h ‘ i ln’ to the ‘capital growthgrowth.transition requires t a s t o equ es

o which the new ly committed.

i l bcome is slower but owthowth.

34

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35

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The changing environmeLast decade

F h

Revenue

• Fast growth as most main early stages of developmentLi it d titi d

Revenue • Limited competition dustructural undersupply

• All firms have pricing po

Costs

• Plentiful supply of laborlow prices

Costs • Low and undifferentiatereal interest rates

Winners

• Fast-growing markets reward those who can efirst and expand capacitfirst and expand capacitmost quickly

nt for Chinese companiesNext decade

k G h i l l larkets

t

• Growth in sales volume slows as markets mature

• More competition as it t h tue to

ower

capacity catches up to demand

• Pricing power falls

r at • Restricted labor supply; high and rising wages

ed • Higher and more differentiated cost of capital

enter ty

• Slower-growing, more crowded markets reward those who can control costs

ty and develop durable competitive advantages

37