[Bottom of Page]  Investment Themes in China Introduction Everybody understands China’s potential. The excitement and anxiety that China’s economic rise generates is well founded. Never in the recorded history of this planet, have so many people risen from poverty. Never have so many transitioned from agricultural to industrial and now to knowledge-based economy in such a short time span. Ironically, the country’s greatest strength and its greatest weakness lie in its size.  On the one hand, its 1.3 billion people are the same people who will buy millions of products and they are the people who make up the vast pool of cheap workers. As a result of this cheap labor pool and dynamic entrepreneurship, China has become the manufacturing powerhouse of the world. It can make goods cheaper than anywhere in the developed world.  On the other hand, the sheer size of the country’s population means that the government must ensure that 24 million new jobs a year are generated, nearly 1/10 of the US population, in order to ensure that the Communist Party of China maintains its fragile legitimacy. Despite the searing 9% per annum growth over the past decade, job creation has barely kept up with new entrants into the Chinese job market. Without the underground economy, China might not have even come close to the level of employment necessary to keep its growing population working. Thus, this necessary job growth limits China’s policy options.  This is why the government is loath to completely allow the renminbi to float and why it is undervalued. If the renminbi should appreciate significantly, Chinese goods, which are selling at razor thin margins, may become unprofitable. If the renminbi appreciates, in order to maintain profits, the prices of Chinese manufactured goods will have to rise thereby reducing their global price competitiveness. The Chinese government is not willing to take the risk of slowing growth and therefore, slowing employment. If the government has to choose between upsetting the US or upsetting its own massive population (with the attendant risk of rising discontent possibly resulting in the overthrow of those in power), it is obvious which they will choose.  Therefore, if China must keep on growing in order to prevent collapse, there are several sectors that are attractive for investments.   Investment Themes in China: 1. The Rise of the Chinese Consumer Credit Suisse carried out a consumer survey of a few thousand urban and suburban households in China. It has forecast China to become the world’s second largest consumer market (in US$ terms) by 2014. This is due to: Rapid economic growth Recent government policy statements and actions that are supportive of consumption growth Significant revisions to official estimates of the size of the Chinese economy in December 2005. In that year, Chinese household consumption spending amounted to US$1 trillion or 3.8% of the global total. Rising after tax disposable incomes. In the 19th century, there was a convergence in real wages between Europe and the US. If this experience is duplicated for China and the West, then it implies rapid gains in household incomes and increase in income inequality in China.   The consumer sectors that are favored: Financial services and Property The bank account is the overwhelmingly popular method of saving (82% of the population). The Bank of China will be soon be listed. BoC is one of the country’s big four lenders and is expected to raise up to $9.9 billion in what would be the world’s biggest listing in six years. China Construction Bank raised $9.2 billion last year. The BoC listing will take place in Hong Kong in early June. BoC will sell 26 billion shares or 10% of the company. If demand is stronger than expected BoC can exercise an option to increase the size of the IPO by a further 15%. This will enable it to raise $11.3 billion and overtake AT&T Wireless’s $10 billion issue six years ago. The size of BoC’s offering is a positive sign for Industrial and Commercial Bank of China, the country’s largest bank, which is going to IPO in Hong Kong and possibly London or New York this year, raising $10 billion plus. We are a little unsure about the quality of the balance sheets of these banks. Ernst & Young forecast nearly US1 trillion of NPLs, subsequently retracted. Beverages Carbonated soft drinks continue to be the most frequently consumed beverages during meals. Coca-cola is still the most frequently consumed non-alcoholic beverage with 27% of the market amongst CS respondents. Monthly spending on alcoholic beverages continues to rise. The increases are driven by those with higher personal incomes. The beer market is highly regionalized but younger beer drinkers are more willing to experiment with foreign brands of beer. Budweiser has risen from 5% to 8% of market share. Internet According to the CS survey, which does not include migrant workers or lower income earners, internet penetration is at 51%. Baidu is the most popular search engine cited by 48% of internet users as the most frequently used. Google is second with 22%. Baidu has recently come up with a censored version of the popular Wikipedia, an online encyclopedia. Online gaming is also very popular. The leading online game is QQ game zone that is sold by Tencent Holdings.   2. The Relentless Growth in Infrastructure Is a corporation a moral agent and therefore, held responsible for its moral actions? If a corporation is morally responsible, how are we to assess corporate morality? Clearly, how we evaluate corporate morality depends on the theoretical framework that we choose to use. The framework, in turn, determines how much we expect from corporations in moral terms. Our expectations can range from zero (corporations cannot be evaluated morally) to very high (corporations are expected to abide by a full range of moral principles.) “China is remaking itself in the image of its superpower mentor, the United States – only more quickly and on a larger scale.” James Kynge, China Shakes the World. Think of the three great infrastructural necessities for a country to develop: roads, rail, and power generation and China has thrown itself into building all of these. Chinese planners know that the US interstate highway system is reckoned to have reduced the costs to American companies of producing goods and services by over $1 trillion in the first forty years of its operation since 1956. Therefore, China is embarking on building highways and all that accompanies them – gas stations, fast-food restaurants, and repair shops. When the interstate highways are done, China’s system will be longer than that of the U.S. Beijing plans by 2030 to have laid 86,000 kilometers, a few thousand kilometers more than the existing US system. China also plans to re-create a version of American’s great nineteenth-century railroad boom. It has plans for a high-speed track to link Beijing to Shanghai and is near to completing the Qinghai-Tibet railway, which is a huge engineering challenge. It must cross over 800 miles that is 14,500 feet above sea level.  One of the most ambitious projects is the Three Gorges Dam project that spans the Yangtze. The Chinese compare it to the building of the Hoover Dam in the 1930s across the Colorado River. It helped create a new regional economy from nothing and raised a city, Boulder, out of a stretch of desert. The Three Gorges Dam is six times as long and eight times as powerful as the Hoover. By 2009, ocean-going vessels will be able to travel all the way from the sea to Chongquing, a distance of 1,250 miles. The city is building two large container ports in anticipation of an upsurge in traffic. Scores of dams larger or around the same size as the Hoover are planned for construction across the upper reaches of the Yangtze, the Mekong, and the Salween. In each year since 2004, China has built enough power plants to supply all the electricity needs of a large European economy such as Italy’s or Spain’s. All this infrastructural building requires huge amounts of raw materials: cement, steel, and copper. Of course, China has the human power, but it must import most raw materials such as copper. This demand is one reason why the price of copper has hit an all time high. Oil is in the $70s per barrel. Steel prices are high and cement factories in China are selling all they can produce. The demand for commodities that has been generated by China’s voracious appetite has contributed to the high level of commodities around the world. As an asides, China Communications Construction Group, an engineering and construction conglomerate with estimated sales of more than US$10 billion is planning a US$1 billion Hong Kong listing that will offer foreign investors the chance to buy into China’s infrastructure boom. The IPO could take place at the end of this year or early 2007.   3. Resources to Feed China’s Appetite If This brings us to our third theme that is the resources that are needed to feed China’s astounding growth. China’s growing appetite, complemented by that of India’s, is helping to create profound shifts in the global terms of trade. Prices of commodities began to pull out of a twenty-year slump in late 2001, which not entirely by coincidence, was also exactly the time that China joined the World Trade Organization. Hundreds of millions of Chinese have begun to seek a new life and many of the things they demand – fuel, metals, food, materials and a certain quality of life – are not available in sufficient quantities within the boundaries of their environmentally exhausted nation. At the top of the list of needs is oil. Twenty years ago, China was the largest oil exporter in East Asia. Now it is the second-largest oil importer in the world. In 2004, it accounted for 31 per cent of the global growth in oil demand, suggesting that the rise in the price of oil is to a significant degree due to the influence of Chinese demand. China has begun to exert an enormous amount of influence on the global markets for raw materials. Take copper as another example. In 1995, Chinese consumption of refined copper was 1.19m tonnes. By 2005, it had more than trebled to 3.61m tonnes. From less than 10 percent of world demand a decade ago, it now accounts for 22 percent. In 2003, it passed the US to become the world’s largest consumer and by 2004, it was consuming 46 percent more than the US. The double-digit annual surge in demand has come from three main sources – construction, power generation, and electricity network. The demand for copper may be reduced in the medium term because the rapid phase of increasing power production capacity is reaching an end. However, on the prospects of the construction sector, the urbanization of the Chinese countryside is just getting started. In addition, even if growth in the Chinese economy slows down the government will not want the growth to stop or reverse. Moreover, it is hard to find substitutes for copper. Therefore, we may see in the long term, that copper prices will remain resilient.  Furthermore, China has invested heavily in copper smelting capacity. This capacity has expanded by more than 70% over the past five years, along with plans for large capacity increases in the future. China is set to replace Chile as the world’s biggest producer of refined metal within the next year. China will therefore be importing more concentrate rather than refined copper in the future. [Top of Page]  [Bottom of Page] 4. The Chinese Reverence for Education As with everything that has to do with Chinese economic rise, there is a good side and a bad side to the Chinese reverence for education. The good side is that there will continue to be strong demand for places at American universities from Chinese students. Those students who attended American universities and worked in American corporations will most likely want to continue to have strong ties with the U.S. This rich network of alumni can be profitably leveraged to attract global talent and resources. The bad side of the Chinese reverence for education is once again the threat of oversupply. The two Asian countries of India and China consistently graduate the world’s greatest numbers of science and engineering PhDs. The quality of these PhDs is becoming comparable in quality to US and European graduates far faster than anyone predicted. Therefore, higher education is becoming as much of a high-tech commodity as circuit boards. India and China already produce nearly 1million engineers a year compared with roughly 170,000 from the US and Europe. This global oversupply of scientists and engineers is of course good news for companies and multinational corporations who are looking for high quality, low cost, scientists and engineers. However, it is probably bad news for western graduates who must now compete in a global marketplace for jobs, with equally qualified, very hard working Chinese and Indian peers. They also have lower salary expectations.    5. Recognizing and Solving Environmental Problems China is faced with mega environmental problems. Think about it. There are 1.3 billion people. They require billions of gallons of clean water. Currently about half the population or about 600 million people have water supplies that are contaminated by animal and human waste.  The era of Communism in China has not been kind to the environment. A combination of neglect, overpopulation, careless industrialization and the inability of a planned economy to put an accurate value on a clean environment have contributed to an environmental crisis that is unparalleled in its severity. There are signs of distress everywhere from the deserts of the north that are marching into the towns and cities on their fringe to the drying up of hundreds of waterways to the contamination of food with alarming levels of animal hormones and agricultural chemicals. It is not surprising that new diseases such as SARS and bird flue appear with regularity. The edifice of Chinese statehood rests on frail ecological foundations.  The current leadership is aware of these problems and has stated that they want China’s growth to be built on a sound environmental basis. Thus, in early 2003, China adopted “sustainable development” as a policy objective. “China’s industrial development is unsustainable because its people, resources, and environment cannot cope.” This is the conclusion made by the State Environmental Protection Administration (SEPA), a branch of Beijing’s Communist government. But this goal of sustainable development is difficult to achieve because of endemic corruption, the lack of resources for SEPA, and the lack of regulatory power of this agency. Unfortunately, the government recently scrapped plans to install a “Green Index” of economic growth because of difficulties in defining its constituents and obtaining accurate data. SEPA has criticized this decision. This is rare for a branch of the government. Industrialization on a Chinese scale will produce massive pollution. The huge population and growing industries will produce tons of waste. Industries will also consume vast resources. According to Liang Congjie, China’s leading independent environmentalist, “If the Chinese wanted to live like Americans, we would need the resources of four worlds to do so.” Pan Yue, deputy director of SEPA, has said that China adopted the west’s resource-hungry model of development even though it was unsuited to a country with a huge population, limited agricultural land, and scarce resources. The solution is to develop renewable energy sources such as solar, wind and hydrogen generation, slash waste, and promote recycling, especially of glass, metals, paper, and water. Investing in the environmental sector therefore makes sense.   Conclusion In this talk, I have tried to highlight the sectors that will probably have sustained and high growth rates. These sectors are the consumer, infrastructural, resource, education, and environmental sectors. Investment in these sectors need not necessarily be confined to China. Resources for instance, are globally traded and some of the best environmental companies are American. However, be warned, China is still a developing country and subject to many risks. There is growing inequality in the country between urban and rural areas and within urban areas. The most alarming feature of China’s income inequality is not its level, which is exceeded by some other developing countries, but the speed at which it has grown. The Chinese leadership has responded with a series of initiatives under the heading of a “new socialist countryside” policy. However, the planned $43 billion earmarked for rural spending this year barely dents the problem. China needs to undertake bold institutional reform. Not least of which is the reform of property law. The world is hoping that the Chinese pragmatism will win over China’s communist party’s desire to stay in power at great cost to the country. It is a balancing act that will be harder and harder to maintain. 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