Wed, 11 Dec 2013
Consumption-led industries will drive Chinese growth for the next decade, and health-care spending, in particular, should outpace China's overall economy, says Morningstar's Dan Rohr.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Dan Rohr; he's an analyst here at Morningstar. He has been closely following China. We're going to get an update on China's growth prospects.
Dan, thanks for joining me today.
Dan Rohr: Thanks, Jeremy.
Glaser: In the past we've talked about some of the challenges that China is going to face in the coming years. But over the past couple of quarters at least, the past couple of months at least, the picture has looked a little bit brighter in China. Is this a sign that the worst is behind them, or is this more of a lull before the storm?
Rohr: We've certainly seen the headline macro indicators tick higher in China. That really kicked off I'd say in July, when we started to see things turn. If you take a look under the hood of some of those indicators, what concerns me and, I think, a lot of the more bearish folks on China is where a lot of the strength was most manifest, and that was on the infrastructure side of the economy, in real estate, things of that nature.
When folks are talking about a hard landing, or at least a deceleration in Chinese economic growth, what they're mainly concerned with is debt.
When you take a look at, say, total credit outstanding in the Chinese economy, that's been what folks have been keeping an eye on. And that's actually grown at double the pace of gross domestic product over the past three quarters, and I don't think we're quite out of the woods yet.
Glaser: The Chinese leadership just completed, relatively recently, its Third Plenum, the meeting where they set out some reforms. We're getting some details there. Do you think these reforms have a chance of making a big difference? What are some of that the major tenets of reform?
Rohr: It's worth pointing out that the document that came out of the Third Plenum was more of a set of broad guidelines, if you will, as opposed to any concrete steps that would be undertaken.
Now with that said, I do think that the vision articulated by that document, implicitly by president Xi Jinping and premier Li Keqiang, is generally favorable as it concerns China's outlook for the next decade to the extent it creates additional space for the market, as opposed to the state, to the extent it would conceivably target reforms that would put China on a more sustainable growth path, one driven by household consumption as opposed to ever more, say, infrastructure and luxury real estate.
Glaser: Are these reforms actually going to be able to be implemented? There are obviously a lot of incumbent players who are benefiting from this infrastructure spending. Is that going to be a smooth transition?
Rohr: That's an excellent point, Jeremy. Of course, this is no longer the China of Mao or Deng where one man's will can be exercised across the country. This is policymaking is a consensus-driven exercise.
I would expect to the extent a lot of these reforms, say Hukou reform, interest-rate reform, and land reform, are going to harm some entrenched interests. We're likely to see the actual reforms watered down when it comes down to the nitty-gritty. Then, when it comes to implementation, I think we're likely to see some heel-dragging.
Certainly, in the past, when we have seen the central government attempt reform, say environmental reform, things of that nature, you have seen significant foot-dragging by the local governments and the state-owned enterprises that were harmed by such policies.
Glaser: If the country is still being driven by this investment-driven economy and these reforms are trying to get them to more of a consumer-driven economy--but obviously, as you mentioned, these reforms aren't going to be the easiest thing in the world to implement--what's your outlook for China then? How are they able to negotiate this tension?
Rohr: Long term, we still see the Chinese economy growing at roughly 5% annually. That'd be our outlook for the next decade. When we take a look back at past examples of countries that have experienced a rebalancing away from the investment-led model to a more sustainable consumption-led model, that would actually rate rather favorably; 5% would be quite good.
While 5% is the average that we expect, we expect it's going to be a rather bumpy 5%, which largely reflects the resolution of some of the risks that have built up within the Chinese system.
Glaser: That's considerably lower than some of the growth they've enjoyed in the recent past. Is that a reason really to maybe avoid Chinese-focused equities or avoid that China story? Should investors beware here?
Rohr: Rebalancing the economy implies a very different set of winners and losers than what we saw in the past decade. Generally speaking, industries oriented to fixed-asset investments--to infrastructure, to real estate development, to manufacturing capacity--they're likely to find the next decade to be quite a bit more challenging, shall we say, than the past decade.
By contrast, generally speaking, the consumption-oriented industries are likely to do quite well. Our favorite at the moment would definitely be health care. We think Chinese health-care spending is going to grow much faster than the economy as a whole. When you take a look at how health-care spending across economies tends to fare, as income levels rise, health-care spending claims a larger share of the total economic pie as those income levels rise.
In addition, as countries get older, which China is going to do quite rapidly over the next decade or so, of course health-care spending rises, as well. So, [these are] two very strong tailwinds, we think, for Chinese health-care spending in the decade to come.
Glaser: Dan, I appreciate your thoughts today.
Glaser: For Morningstar, I'm Jeremy Glaser.