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China's Next Growth Story

Jason Stipp

Stipp: When you're thinking about the companies that you're investing in, in China, how do you factor in the possibility for either slower growth or inflation, and how do you find companies that can weather through an environment that maybe China is facing?

Gao: I think, China is today facing a very different challenge than the last year. The overall growth has been very strong so far this year, and last year, it was all about how to boost the overall economic growth in China.

And then the government laid out this stimulus program to try to stimulate the growth, and that stimulus program has been working very well. And in fact, it's been working too strongly that the government wants to slow it down.

And when you look at the inflation rate, although the absolute inflation number is still not that high, it is currently at around 3%, and that is also the target for the government of this year that they want to achieve the inflation rate of 3%. But, if you look at the momentum of the inflation growth in China, it's actually last year, it's in the deflationary period. And this year, you already see a 3% inflation. So that has caused us some concern about the rapid growth rate of inflation rate.

But on the other hand – on the more positive side, we are glad to see that the government has actually treated this scenario very seriously, and they realize the problem of overheating and inflation in the future, and they have been rolling out a lot of tightening measures especially in the property areas, and also rolling out measures such as raising bank reserve ratios, and also slowing down loan growth. So we are cautiously optimistic that the government should be able to achieve a soft landing in the second half of this year.

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Stipp: Okay. Another issue I think that is on some investors' minds with respect to China is, how their exports will fare in a developed world that is facing lots of debt issues, talk of austerity measures in Europe, and certainly the United States, the debt issues are getting a lot more concern. A lot of people are talking about a slower growth environment and lot of folks are looking to emerging markets as an area where they might get better growth.

But on the flipside of that, if the developed world is consuming less, what are the engines that might be able to take its place? I think, domestic consumption in China is something that possibly could. When you're thinking about the companies you invest in, in China, how do you think about their domestic prospects and their export prospects, and what do you think is going to be a growth driver for China going forward?

Gao: I think, going forward, China's economic growth will definitely be more and more coming from within China, and this has always been a key investment theme for Matthews here, and we believe that China's growth will no longer be just relying on the investment growth or the export growth, but with the income growth and living standards improvement coming out of China, we are going to see more and more growth coming from within China and this has also been one of the key government working areas in recent years. Government has been giving out lot of positive policies to stimulate the domestic consumption. For example, they just raised the minimum wage in many of the provinces, especially in the inner part of China, and also they are spending a lot of money in the infrastructure buildup and also in the social welfare network buildup.

So, as a result of those kind of measures, we believe that the consumer confidence and purchasing power because of the living standard improvement and income improvement, you'll see more and more middle class coming out of China. And as a matter of fact, right now there are already more than 300 million middle-class people in China, and those middle-class people will become the key purchasing power for the growth in China.

Stipp: So sort of a follow-up question on that front. If you're looking to target companies for the fund that might benefit from this increase in domestic consumption, what kind of companies are you looking at that you think will really benefit from that trend?

Gao: We have been focusing on the domestic consumer-related companies, and the way we have been investing in this area is that we have been trying to follow the evolution of the domestic consumer pattern in China.

So for example, when the Matthews China Fund restarted in the late 1990s, our focus of the consumption area were on the areas like the white goods and home improvement products. And at that time, the average income level was about $700 to $800 per year.

And then in the next 10 years, I think, we're seeing a very strong income growth going forward. And today, the average per capita income is now around $3,000. So we are seeing the evolvement of consumer patterns from the white goods and home improvement products to banks to service-related products to insurance products and to luxury goods and leisure products, and also to information technology areas. So, over the years, the focus of our consumer area has been also evolving to follow the consumer pattern change in China.