China is in the midst of a momentous shift from a manufacturing economy to a service economy driven by domestic consumption. As policymakers manage one of the biggest economic transitions in history, the challenges cannot be underestimated. Economic growth has slowed sharply.
Last year, China recorded GDP growth of 6.9 per cent, the slowest rate of economic growth in more than two decades. For 2016, the IMF forecasts GDP will slow further to 6.5 per cent and then flatten out to 6 per cent by 2020. Others forecast a sharper economic slow down. The Economist Intelligence Unit, for instance, projects growth to slow to 4.7 per cent by 2020.
While China's economic transition can at times unsettle global investors, it also ushers in a brand new era of investment opportunities. This shift in opportunities is having an effect on US companies as they re-think their investment strategies in China. In a recent survey of more than 300 US executives at mid-market companies conducted by the EIU and sponsored by HSBC, half of respondents said that since the beginning of 2016, their confidence in reaching goals set for their operations in China had increased compared with 38 per cent expressing decreased confidence. In terms of future decisions, 53 per cent of respondents plan to increase investment in China this year compared with 31 per cent planning a decrease. "It depends what industry you operate in as to whether China is an opportunity," said Debra Lodge, Managing Director Global Markets and Head of RMB Business Development and Sales Americas at HSBC. "Despite some companies planning to decrease investment in China, we see huge growth potential for our middle market companies."
It depends what industry you operate in as to whether China is an opportunity, despite some companies planning to decrease investment in China, we see huge growth potential for our middle market companies.
Debra Lodge, Managing Director Global Markets and Head of RMB Business Development and Sales Americas at HSBC
Many investment opportunities in China today derive from the rapid growth of "e-tailing". Mega sites like PaiPai, Taobao, and Tmall dominate the online retail industry while a growing number of service providers offer critical support for marketing and website design, delivery and logistics, customer service, IT and payments. According to McKinsey & Company, some 90 per cent of Chinese electronic retailing occurs on virtual marketplaces, sites similar to Amazon or eBay, compared with only 20 per cent to 30 per cent in the United States.
As the Chinese economy changes from investment driven growth to consumption fuelled growth, these virtual marketplaces are only expected to grow in importance. In addition, demand for higher end consumption items like apparel, cosmetics, recreation and leisure, as well as education should all grow. HSBC forecasts that retail sales could continue to grow an annual 10 per cent over the next 2 years (compared 2.3 per cent YTD USA retail sales growth according to Bloomberg). As e-tailing expands so too will support industries including infrastructure and logistics companies, supply chain management companies, IT services and digital marketing. In turn demand for automobiles, trucks and airplanes to shift products and people should increase. "Mid-market companies are providing parts to all these industries," said Ms. Lodge, "Things like brake linings, seals around doors, parts for airplanes or in health care devices used in hip or joint replacement."
Then there are additional industries on the rise. Tourism may be more important both as more Chinese travel abroad (only 5 per cent of the population currently hold a passport) as well as more visits by foreigners to China (large US cruise liners are now docking in ports like Shanghai). Green industries and related expertise will also be in demand as China looks to make its buildings, appliances and vehicles more energy efficient and designs sustainable cities and urban communities.
The main area where investment is visibly declining is in low-end manufacturing. As labor costs in China increase, more companies are shifting low-end manufacturing operations out of China and into developing Asian countries like Vietnam, Indonesia and Thailand. According to the EIU and HSBC survey of mid market companies, an overwhelming 74 per cent of respondents will maintain or increase their investments in emerging Asia this year.
While there are many new investment opportunities in China, challenges remain for US companies operating there. China has made tremendous strides in opening up its economy to foreign investment. But it can still be perceived as a country that is difficult to do business in. Rules can change overnight and from region to region, paperwork can be onerous and regulations may prove tricky to ensure compliance. "It's very important for middle market companies to have a partner they can trust and get good advice on the ground," said Ms. Lodge. Then there is macro risk. Earlier this year ratings agencies downgraded their outlook for the Chinese government's credit rating. As economic growth has slowed, ratings agencies are worried that total debt is increasing, making the Chinese economy more vulnerable to shocks. Finally, a significant risk to the booming e-tailing sector may be a growing talent shortage and sharply rising labor costs. That could result in a sudden brake on growth and investment that would also ripple through the many support industries.
China's economic progress to date has been nothing short of remarkable. While China faces challenges in terms of growing debt levels, slowing economic growth and the urgent need for exchange rate reform, it has significant advantages that set it apart from almost any other large economy today. "Is there an economic slow down? Yes but worries of a sharp slow down are over blown," said Ms. Lodge. "Our view on China is that it is in a much better state than the perceptions. It has huge untapped economic potential, strong reserves, and many tools in its toolbox to effect reform." In other words, there is a good chance China may keep proving the skeptics wrong.
Is there an economic slow down? Yes but worries of a sharp slow down are over blown, our view on China is that it is in a much better state than the perceptions. It has huge untapped economic potential, strong reserves, and many tools in its toolbox to effect reform.
Debra Lodge, HSBC
This article has been prepared and is being distributed in the United States by the Commercial Banking Department within HSBC Bank USA, N.A., Member FDIC ("HSBC" or the "Bank"). The Bank is a member of the HSBC Group that operates through a network of affiliates and subsidiaries around the world. All market data dated 2Q2016, unless otherwise indicated within this material.
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