Probably the single biggest investment issue for markets and emerging market assets is China. Is the Chinese economy stalling and about to tip into a recession as the bears believe? Or is this a slow gradual downshift in growth as the economy transitions to new growth drivers? Which side you sit in this debate will to a large extent determine your risk appetite and positioning.
China is emerging from the most intense period of domestic investment in the history of any economy. As observers have pointed out, China poured more concrete in the last decade than the US has done in its entire history as a nation. China accounts for more than 50 per cent of global demand for steel, aluminium, copper and a whole host of other commodities. That they have invested massively is in little doubt, just go to China and see the improvement in infrastructure. It is breath-taking.
The core debate is this. Have they built the right infrastructure in the right place, providing a base to productivity enhancement and letting the service sector reap the gains of this build-out? Alternatively, if much of the infrastructure build-out is simply the wrong stuff in the wrong place, or just money siphoned out, then China will be left with a mountain of debt, the servicing of which will be in doubt.
Despite all the recent scepticism around Chinese policymakers, the botched intervention in the stock market and the yuan depreciation aside, there does seem to be a long-term game-plan to transition the economy. There is a re-balancing strategy to transition to services and the consumer, slow down fixed asset growth, move up the value chain in manufacturing and dampen credit growth. This is exactly what Western policymakers have been imploring China to do over the last few years. Now that it is moving down this path everyone is convinced the economy is on the verge of collapse.
As faith in China's policymaking and the economic data has declined over the past few months, many investors for lack of anything better have reverted to old indicators and rules of thumb to judge the economy's health. One hears again of the Li Keqiang index (power demand, rail freight and credit formation). This index was useful to measure the economy of an industrial province in China (Liaoning) in 2007. It is to my mind rubbish in trying to give you a read of today's China and the new growth drivers of services and the consumer. If you look at the Li Keqiang index today, it shows the Chinese economy just starting to emerge from a recession that has been in place through much of 2014. As the economy transitions (80 per cent of GDP growth in the first half of 2015 came from services, and services are now 50 per cent of the Chinese economy), naturally this index will show steep declines. Service sectors require less rail transport, are much less-power intensive in their growth and also tend to be a lot less capital-intensive than manufacturing or infrastructure. The weakness in the Li Keqiang index does not mean the Chinese economy is imploding.
Bernstein, the investment management firm, has laid out a whole series of indicators, which they feel give a much better read of the Chinese consumer and the services economy. They look at airline passenger growth, 4G mobile subscriptions, movie ticket sales, Alibaba gross merchandise value (GMV), residential property prices and car sales. If you look at this series of data things look far better, with strong growth in each metric barring car sales. The weakness in cars may be due to licence plate restrictions. Alibaba GMV is up 30 per cent, airline volumes are up 10 per cent, 20 million new 4G subscriptions are being added monthly, the movie box office was up 40 per cent etc. This does not look like an economy on the verge of collapse or where the consumer is in recession.
China is therefore a story in two parts. Most industrial metrics look awful; truck sales, power production, international trade, new housing starts, railway freight and the manufacturing PMI, are all negative or show zero growth. This is only to be expected as the transition to services will mean slower fixed asset and manufacturing growth. However, consumer and service sector metrics show strong traction. Which data set is more representative of China today and its future growth drivers? Which series should we track?
While the weakness on the industrial side is fully relevant to understand the weakness in global commodities, it is very unlikely that you can use these metrics to judge the whole Chinese economy in the manner which was relevant in the past.
Just as the economy has begun the process of pivoting towards services and consumption, we as investors have to pivot towards more relevant data sets to judge the new China.
The big question for China watchers will be as to whether there is enough growth in the new China to compensate for the slower (by design) growth of the old China of infrastructure and mass manufacturing. Can you in effect supplant the old economy without a crisis? An easy way to quantify this is to look at corporate earnings.
Bernstein has done just that, looking at almost 1800 companies with China exposure or domicile. This data set shows negative two per cent revenue, six per cent earnings growth and capex declines of eight per cent for the latest quarter. Debt for these companies is also starting to decline. The micro seems to confirm the macro view of an economy where fixed asset and credit growth is slowing and debt is starting to come under control. This data does not indicate that corporate China is in a crisis. We are not seeing the steep profit declines typical for a recessionary economy.
The Chinese economy is not collapsing, it is shifting to different growth drivers which the old metrics used to judge China do not pick up. We in India should focus on revving up our own growth drivers instead of gloating over the coming demise of China. For the world to truly take us seriously we need to deliver on our own fundamental structural reform. It is no point being seen as the best ship in a poor neighbourhood. The TINA trade will not last forever.
The writer is at Amansa Capital. These views are his own