Why it’s dangerous to underestimate China

Photo by China Photos/Getty Images

Even after a year of headlines about China’s economic slowdown, people can get a bit excitable about opportunities in the world’s second-largest economy.

The economy is, after all, still growing at more than 6% (on official numbers) and this is helping to swell the ranks of the Chinese middle class.

Witness the explosion in Blackmores’ share price last week. When the company announced it was partnering with dairy company Bega to make infant formula for the Chinese market, the stock soared through the $200 mark, making it the first Australian company with shares valued at that level.

Nomura analysts felt the need to tell everyone to calm down a bit.

Despite all the horrible headlines about China – the stock market imploded, nobody believes the economic growth figures, and the government is trying to force through some difficult reforms – there is plenty of evidence that the economy is making the all-important transition to more consumption-based sources growth as the overall growth lifts the wealth of its citizens.

Last week, for example, Apple CEO Tim Cook said on an earnings call that, from where he sat, there wasn’t much of a problem in China.

“Frankly if I were to shut off my web and shut off the TV and just look at how many customers are coming into our stores regardless of whether they’re buying, how many people are coming online, and in addition looking at our sales trends, I wouldn’t know that there was any economic issue at all in China,” Cook said.

He added that iPhone sales were up 87% for the year. So for some companies, China is a great market right now.

This chart, shared in a recent note from Capital International, shows how some consumer sectors are ripening in China:

Charts: Capital International

Stephen Green, an economist with Capital International, explains:

China’s GDP growth rate often understates consumption. For example, the government does a good job of capturing the number of cars produced, but a very bad job of tracking the number of karaoke nights that people are enjoying, or the restaurants and coffee shops they are visiting, or travel-related activity, or even online shopping. That’s where the growth is. Many independent surveys suggest that there is a lot more consumption going on than the official statistics suggest, which means the economy is probably more balanced than people think.

His colleague China affairs specialist Andrew Dougherty adds:

Wages continue to grow on average 5% to 7% per year on a nationwide basis, and are still growing in some regions and sectors 10% to 15% per annum, even in the current slower growth environment. This puts money in the pockets of the masses. Even though luxury goods consumption has fallen sharply, mass market consumption is still quite healthy. We see this in the online shopping numbers and healthcare expenditures.

Sure, growth in China’s nightlife and online shopping might seem like an unlikely replacement for the waning in the vast manufacturing sector that China has thrived on, but it’s worth remembering China’s middle class is on its way to being mind-bogglingly huge. ANZ estimates, for example, that there’ll be over 200 million affluent and middle income households in China by 2025, and the urban population is expected to grow to more than 850 million over the next 15 years.

That’s about two-and-a-half times the size of the entire United States.

Beijing’s communique from its gathering of the Chinese Communist Party last week restated several goals that underline the shift to a consumption based economy, including a goal of building “a moderately prosperous society by 2020”, and having “balanced, inclusive and sustainable growth”.

Nomura believes the economic plan “requires both GDP and household income per capita to double by 2020 from that of 2010” and estimates “that it needs average annual GDP growth of around 6.5% over 2016-20)”.

This a number many will be skeptical can be achieved. China’s economy is in a rocky place at the moment but the combination of its vast population and the total policy authority of its government make for a combination that has the potential to surprise.