May 2019 China in 2019: Pursuing a middle-income growth model
Natural slowdown, bigger global contribution We believe China’s economy is bound to slow as it matures and relies more on consumption – similar to what happened with regional peers China’s contribution to global growth will still remain significant, in our opinion China Has High Real GDP but Low Per Capita Income China Has Been a Major Contributor to Global Growth 15 45 250 China 40 Value of 1% Nominal GDP Growth, PPP USD Share of Global Real GDP Growth, % 200 10 35 Malaysia 30 150 Real GDP Growth 5 South Korea 25 20 100 0 15 10 50 -5 5 0 0 * 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 -10 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 China's share of world real GDP growth, % Per capita income (PPP basis), USD Value of China's 1% nominal GDP growth, PPP USD bn Source: VanEck; Bloomberg. GDP: gross domestic product. PPP basis: Adjusted based on purchasing power parity, which accounts for differences in price levels. *Although not shown, china accounted for 100% of Global Real GDP in 2009. 2
Innovation, economic complexity ahead of peers We believe China’s innovation record is impressive Economic complexity is significantly above the peer group China Has a Diverse and Sophisticated Economy 2.5 2 1.5 China France Israel 1 Mexico Economic Complexity Index 0.5 Turkey 0 Brazil -0.5 -1 -1.5 -2 7 8 9 10 11 12 Per Capita GDP, PPP basis (ln) Source: VanEck, Bloomberg LP (left). The Economic Complexity Index ( ECI ) is a holistic measure of the productive capabilities of large economic systems, usually cities, regions, or countries. In particular, the ECI looks to explain the knowledge accumulated in a population and that is expressed in the economic activities present in a city, country, or region. To achieve this goal, the ECI defines the knowledge available in a location, as the average knowledge of the activities present in it, and the knowledge of an activity as the average knowledge of the places where that economic activity is conducted. 3
Secular transformation to consumption-based economy Rising middle class drives secular transformation to consumption-base economy – higher incomes are associated with a higher share of services in GDP The share of GDP driven by investment is slipping below 30% and services account for nearly 60% of fixed investments As Income Rises, so Does Services Share China’s Growth Increasingly Driven by Consumption* 58 100 90 2023F 56 80 Services Share in Nominal GDP, % 54 Contribution to GDP Growth (%) 2020F 70 52 60 50 50 48 40 46 30 20 44 China Services Share of Nominal GDP vs China Per Capital Income, Quarterly Observations 10 42 From March 2005 - September 2018 0 40 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 0 5,000 10,000 15,000 20,000 25,000 Consumption Investments PPP-Based Per Capita GDP ($) Source: Bloomberg LP. GDP: Gross Domestic Product. *Consumption refers to activities that directly provide utility to people, and investment refers to the accumulation of capital goods 4
Transformation has costs – widening macro imbalances China accumulated multiple macroeconomic imbalances while getting richer China’s leverage – including corporates – is among the highest in the world So is M2/GDP ratio Past Growth Was Fueled by Additional Debt The Supply of Money is Still High 300 180 160 250 M2 Money Supply to GDP (%) 140 120 200 Debt to GDP (%) 100 150 80 60 100 40 50 20 0 0 ARGENTINA BRAZIL INDONESIA MEXICO TURKEY RUSSIA COLOMBIA PHILIPPINES SOUTH AFRICA HUNGARY POLAND ISRAEL CHILE CANADA UNITED STATES CZECH REPUBLIC EUROZONE AUSTRALIA MALAYSIA SWITZERLAND THAILAND SOUTH KOREA JAPAN CHINA Dec-04 Jul-05 Feb-06 Sep-06 Apr-07 Nov-07 Jun-08 Jan-09 Aug-09 Mar-10 Oct-10 May-11 Dec-11 Jul-12 Feb-13 Sep-13 Apr-14 Nov-14 Jun-15 Jan-16 Aug-16 Mar-17 Oct-17 China total debt/GDP China corporate debt/GDP Source: Bloomberg LP (left); Unassuming Economist (right). M2 is a calculation of the money supply that includes cash and checking deposits, savings deposits, money market securities, mutual funds and other time deposits. 5
Price deflation reignited debt concerns Even though the producer price index (PPI) is driven mostly by commodity prices… …it pushes nominal GDP lower, worsening China’s debt/GDP ratio Decreasing Prices Have Pushed Down Nominal GDP PPI and Oil Prices are Highly Correlated 30 10 80 Brent crude price change (% annual change ) 8 25 60 6 PPI (% annual change) 20 40 % (annual change) 4 15 20 2 10 0 0 5 -2 -20 0 -4 -40 -5 -6 -10 -8 -60 Mar-01 Jan-02 Nov-02 Sep-03 Jul-04 May-05 Mar-06 Jan-07 Nov-07 Sep-08 Jul-09 May-10 Mar-11 Jan-12 Nov-12 Sep-13 Jul-14 May-15 Mar-16 Jan-17 Nov-17 Sep-18 Dec-11 May-12 Oct-12 Mar-13 Aug-13 Jan-14 Jun-14 Nov-14 Apr-15 Sep-15 Feb-16 Jul-16 Dec-16 May-17 Oct-17 Mar-18 Aug-18 PPI, %yoy Brent, %yoy Nominal GDP, %yoy PPI, %yoy Source: VanEck Research, Bloomberg LP. PPI: Producer Price Index. 6
Price deflation has implications for corporates Lower PPI and nominal GDP growth may eat into corporate profits… …which can be problematic as debt servicing ratios remain high Declining Prices Reflected in Corporate Profits Private Debt Service Coverage Ratio is Elevated 35 10 30 Turkey, 27.7 30 8 25 Industrial profits (% annual change) Debt service coverage ratio (%) 25 6 China, 19.3 PPI (% annual change) 20 4 20 15 2 15 US, 14.7 10 0 South Africa, 10 5 -2 8.9 0 -4 Mexico, 5.1 5 -5 -6 0 -10 -8 Mar-05 Nov-05 Jul-06 Mar-07 Nov-07 Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13 Nov-13 Jul-14 Mar-15 Nov-15 Jul-16 Mar-17 Nov-17 Jul-18 Dec-11 May-12 Oct-12 Mar-13 Aug-13 Jan-14 Jun-14 Nov-14 Apr-15 Sep-15 Feb-16 Jul-16 Dec-16 May-17 Oct-17 Mar-18 Aug-18 Industrial profits, %yoy PPI, %yoy Source: VanEck Research, Bloomberg LP. Debt service coverage ratio is the ratio of cash available to debt servicing for interest, principal and lease payments. 7
Dealing with imbalances is painful China has begun to address some of the most pressing issues – high leverage and shadow banking However, the deleveraging drive hit the private sector and smaller companies the hardest in our opinion, while State Owned Enterprise (“SOE”) borrowing costs remained almost untouched China Lending: New Loans Up, Shadow Banking Down Deleveraging Has Raised Borrowing Costs for Non-SOEs 120 30 400 New CNY Loans, 12-Month Rolling Sum, % Change yoy 350 100 20 Shadow Financing, % Change yoy 300 80 10 250 Spread, bps 60 0 200 40 -10 150 20 -20 100 0 -30 50 -20 -40 0 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 2015 2016 2017 2018 2019 Central SOEs Local SOEs Non-SOEs Shadow Financing, %yoy New CNY Loans, 12m rolling sum, %yoy Source: VanEck, Bloomberg LP (left); UBS (right). SOE: State-Owned Enterprise. Shadow banking comprises private credit intermediation occurring outside the formal banking system. 8
Some traditional policy tools appear less effective We believe the transmission mechanism is not working properly in 2018, as past policy moves (2018 RRR cuts) failed to ease China’s financial conditions as they had in the past easing cycles The PBoC, however, persevered, and the “drip stimulus” approach is finally bringing fruit Citi China Financial Conditions Index 1 ← tightening loosening → April 2018: Cut 1% 0.5 October 2018: April 2015: Cut 1% Cut 1% 0 -0.5 July 2018: Cut 0.5% February 2015: Cut 0.5% January 2019: Cut 1% -1 September 2016: Cut 0.5% October 2016: Cut 0.5% March 2016: Cut 0.5% -1.5 -2 -2.5 Source: Bloomberg. RRR: required reserve ratio. 9
Fiscal stance remains stimulative Authorities are relying more on policy support through fiscal channels, in our view China’s budget deficit was at historic wide in 2018… …albeit not as wide as it was in the U.S. after the global financial crisis China Fiscal Balance, % GDP 4 2 Fiscal Balance as % of GDP 0 -2 -4 -6 -8 -10 -12 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 China Fiscal Balance, % GDP U.S. Fiscal Balance, % GDP Source: Bloomberg. 10
China growth forecasts becoming less pessimistic Downward revisions to GDP growth forecasts appear to have bottomed out We believe drip stimulus is kicking in China Growth Forecast Revisions Show Drip Stimulus Effect 101.5 101.3 101.1 100.9 100.7 100.5 100.3 100.1 99.9 99.7 99.5 Source: VanEck; Bloomberg LP. 11
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