China in 2019: Pursuing a middle-income growth model Natural - - PowerPoint PPT Presentation

China in 2019: Pursuing a middle-income growth model

May 2019

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5 10 15 20 25 30 35 40 45 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Value of 1% Nominal GDP Growth, PPP USD Share of Global Real GDP Growth, %

China Has Been a Major Contributor to Global Growth

China's share of world real GDP growth, % Value of China's 1% nominal GDP growth, PPP USD bn

China Malaysia South Korea

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5 10 15 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 Real GDP Growth Per capita income (PPP basis), USD

China Has High Real GDP but Low Per Capita Income

Natural slowdown, bigger global contribution

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Source: VanEck; Bloomberg. GDP: gross domestic product. PPP basis: Adjusted based on purchasing power parity, which accounts for differences in price levels. *Although not shown, china accounted for 100% of Global Real GDP in 2009.

• We believe China’s economy is bound to slow as it matures and relies more on consumption – similar to what happened with regional peers
• China’s contribution to global growth will still remain significant, in our opinion

*

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Source: VanEck, Bloomberg LP (left). The Economic Complexity Index (ECI) is a holistic measure of the productive capabilities of large economic systems, usually cities, regions, or countries. In particular, the ECI looks to explain the knowledge accumulated in a population and that is expressed in the economic activities present in a city, country, or region. To achieve this goal, the ECI defines the knowledge available in a location, as the average knowledge of the activities present in it, and the knowledge of an activity as the average knowledge of the places where that economic activity is conducted.

Innovation, economic complexity ahead of peers

• We believe China’s innovation record is impressive
• Economic complexity is significantly above the peer group

Brazil China France Israel Mexico Turkey

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0.5 1 1.5 2 2.5 7 8 9 10 11 12 Economic Complexity Index Per Capita GDP, PPP basis (ln)

China Has a Diverse and Sophisticated Economy

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Source: Bloomberg LP. GDP: Gross Domestic Product. *Consumption refers to activities that directly provide utility to people, and investment refers to the accumulation of capital goods

Secular transformation to consumption-based economy

• Rising middle class drives secular transformation to consumption-base economy – higher incomes are

associated with a higher share of services in GDP

• The share of GDP driven by investment is slipping below 30% and services account for nearly 60% of fixed

investments 2023F 2020F

40 42 44 46 48 50 52 54 56 58 5,000 10,000 15,000 20,000 25,000 Services Share in Nominal GDP, % PPP-Based Per Capita GDP ($)

As Income Rises, so Does Services Share

10 20 30 40 50 60 70 80 90 100 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Contribution to GDP Growth (%)

China’s Growth Increasingly Driven by Consumption*

Consumption Investments

China Services Share of Nominal GDP vs China Per Capital Income, Quarterly Observations From March 2005 - September 2018

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Source: Bloomberg LP (left); Unassuming Economist (right). M2 is a calculation of the money supply that includes cash and checking deposits, savings deposits, money market securities, mutual funds and other time deposits.

Transformation has costs – widening macro imbalances

• China accumulated multiple macroeconomic imbalances while getting richer
• China’s leverage – including corporates – is among the highest in the world
• So is M2/GDP ratio

50 100 150 200 250 300 Dec-04 Jul-05 Feb-06 Sep-06 Apr-07 Nov-07 Jun-08 Jan-09 Aug-09 Mar-10 Oct-10 May-11 Dec-11 Jul-12 Feb-13 Sep-13 Apr-14 Nov-14 Jun-15 Jan-16 Aug-16 Mar-17 Oct-17

Debt to GDP (%)

Past Growth Was Fueled by Additional Debt

China total debt/GDP China corporate debt/GDP 20 40 60 80 100 120 140 160 180 ARGENTINA BRAZIL INDONESIA MEXICO TURKEY RUSSIA COLOMBIA PHILIPPINES SOUTH AFRICA HUNGARY POLAND ISRAEL CHILE CANADA UNITED STATES CZECH REPUBLIC EUROZONE AUSTRALIA MALAYSIA SWITZERLAND THAILAND SOUTH KOREA JAPAN CHINA

M2 Money Supply to GDP (%)

The Supply of Money is Still High

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Source: VanEck Research, Bloomberg LP. PPI: Producer Price Index.

Price deflation reignited debt concerns

• Even though the producer price index (PPI) is driven mostly by commodity prices…
• …it pushes nominal GDP lower, worsening China’s debt/GDP ratio
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20 40 60 80

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2 4 6 8 10 Dec-11 May-12 Oct-12 Mar-13 Aug-13 Jan-14 Jun-14 Nov-14 Apr-15 Sep-15 Feb-16 Jul-16 Dec-16 May-17 Oct-17 Mar-18 Aug-18 Brent crude price change (% annual change) PPI (% annual change)

PPI and Oil Prices are Highly Correlated

PPI, %yoy Brent, %yoy

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5 10 15 20 25 30 Mar-01 Jan-02 Nov-02 Sep-03 Jul-04 May-05 Mar-06 Jan-07 Nov-07 Sep-08 Jul-09 May-10 Mar-11 Jan-12 Nov-12 Sep-13 Jul-14 May-15 Mar-16 Jan-17 Nov-17 Sep-18 % (annual change)

Decreasing Prices Have Pushed Down Nominal GDP

Nominal GDP, %yoy PPI, %yoy

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Source: VanEck Research, Bloomberg LP. Debt service coverage ratio is the ratio of cash available to debt servicing for interest, principal and lease payments.

Price deflation has implications for corporates

• Lower PPI and nominal GDP growth may eat into corporate profits…
• …which can be problematic as debt servicing ratios remain high
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2 4 6 8 10

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5 10 15 20 25 30 35 Dec-11 May-12 Oct-12 Mar-13 Aug-13 Jan-14 Jun-14 Nov-14 Apr-15 Sep-15 Feb-16 Jul-16 Dec-16 May-17 Oct-17 Mar-18 Aug-18 PPI (% annual change) Industrial profits (% annual change)

Declining Prices Reflected in Corporate Profits

Industrial profits, %yoy PPI, %yoy

US, 14.7 Mexico, 5.1 South Africa, 8.9 Turkey, 27.7

5 10 15 20 25 30 Mar-05 Nov-05 Jul-06 Mar-07 Nov-07 Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13 Nov-13 Jul-14 Mar-15 Nov-15 Jul-16 Mar-17 Nov-17 Jul-18 Debt service coverage ratio (%)

Private Debt Service Coverage Ratio is Elevated

China, 19.3

Dealing with imbalances is painful

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• China has begun to address some of the most pressing issues – high leverage and shadow banking
• However, the deleveraging drive hit the private sector and smaller companies the hardest in our opinion, while State Owned Enterprise

(“SOE”) borrowing costs remained almost untouched

Source: VanEck, Bloomberg LP (left); UBS (right). SOE: State-Owned Enterprise. Shadow banking comprises private credit intermediation occurring outside the formal banking system.

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10 20 30

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20 40 60 80 100 120 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 New CNY Loans, 12-Month Rolling Sum, % Change yoy Shadow Financing, % Change yoy

China Lending: New Loans Up, Shadow Banking Down

Shadow Financing, %yoy New CNY Loans, 12m rolling sum, %yoy 50 100 150 200 250 300 350 400 2015 2016 2017 2018 2019 Spread, bps

Deleveraging Has Raised Borrowing Costs for Non-SOEs

Central SOEs Local SOEs Non-SOEs

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0.5 1 ← tightening loosening →

Citi China Financial Conditions Index

Some traditional policy tools appear less effective

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Source: Bloomberg. RRR: required reserve ratio.

• We believe the transmission mechanism is not working properly in 2018, as past policy moves (2018 RRR cuts) failed to ease China’s

financial conditions as they had in the past easing cycles

• The PBoC, however, persevered, and the “drip stimulus” approach is finally bringing fruit

March 2016: Cut 0.5% April 2018: Cut 1% October 2018: Cut 1% January 2019: Cut 1% September 2016: Cut 0.5% October 2016: Cut 0.5% April 2015: Cut 1% February 2015: Cut 0.5% July 2018: Cut 0.5%

Fiscal stance remains stimulative

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Source: Bloomberg.

• Authorities are relying more on policy support through fiscal channels, in our view
• China’s budget deficit was at historic wide in 2018…
• …albeit not as wide as it was in the U.S. after the global financial crisis
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2 4 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Fiscal Balance as % of GDP

China Fiscal Balance, % GDP

China Fiscal Balance, % GDP U.S. Fiscal Balance, % GDP

• Downward revisions to GDP growth forecasts appear to have bottomed out
• We believe drip stimulus is kicking in

China growth forecasts becoming less pessimistic

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Source: VanEck; Bloomberg LP.

99.5 99.7 99.9 100.1 100.3 100.5 100.7 100.9 101.1 101.3 101.5

China Growth Forecast Revisions Show Drip Stimulus Effect

Services look fine and manufacturing may be turning

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Source: Bloomberg. Purchasing Manager Index: is an indicator of economic health of a sector.

• We believe China’s manufacturing investments are rebounding
• Services look steady and new orders are rebounding

49 50 51 52 53 54 55 56 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Apr-18 Jun-18 Aug-18 Oct-18 Dec-18 Feb-19 Apr-19

China Services PMIs

China's Official Services PMI China's Caixin Services PMI 49 50 51 52 53 54 55 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Apr-18 Jun-18 Aug-18 Oct-18 Dec-18 Feb-19 Apr-19

China Manufacturing PMIs

China's Manufacturing PMI China's New Orders PMI

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Left chart: Source: BofA Merrill Lynch Global Research, CEIC. Right chart: Source: BofA Merrill Lynch Global Research estimates, CEIC, Wind, PBoC. Other financial assets include stock, bond, insurance, trust and peer to peer investments.

Important policy buffer: household balance sheets

50 100 150 200 250 300 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 RMB trillion

Balance Sheets Have Grown Steadily

Asset Liability Net asset

• We believe household balance sheets are currently in good shape
• However, property comprises a large portion of household assets and consumer confidence shows strong correlation with housing sector
• A sustained drawdown in housing prices could have an outsized impact on consumer confidence and spending

95 100 105 110 115 120 125 130 95 100 105 110 115 120 125 130 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14 Mar-15 Aug-15 Jan-16 Jun-16 Nov-16 Apr-17 Sep-17 Feb-18 Jul-18 Dec-18

Consumer confidence and housing prices are closely linked

Second-hand houses price index, Jan 2011=100 Consumer confidence index

Geopolitical considerations to grow in importance

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Sources: Bloomberg as of 1/25/2019. Past performance is not indicative of future results.

• Trade dispute with the U.S. is affecting trade flows and confidence
• We believe geopolitical issues will not disappear any time soon as U.S. demands strike at the heart of China’s growth/social model
• Some supply chains may shift out of China
• China establishing alternative geopolitical networks/structures
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10 20 30 40 50 60 Jan-00 Jun-00 Nov-00 Apr-01 Sep-01 Feb-02 Jul-02 Dec-02 May-03 Oct-03 Mar-04 Aug-04 Jan-05 Jun-05 Nov-05 Apr-06 Sep-06 Feb-07 Jul-07 Dec-07 May-08 Oct-08 Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 Jul-17 Dec-17 May-18 Oct-18

US-China Trade: Exports to China

US exports to China (US Census Bureau), 3mma %yoy China imports from US (Customs General Administration PRC), 3mma %yoy

U.S. currency demands may create problems down the road

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Sources: Bloomberg. Real effective exchange rate is an index that describes the strength of a currency relative to a basket of currencies of a country’s trading partners, taking into account differences in price levels in each country. Current account: the current account consists of the balance of trade, net primary income or factor income and net cash transfers, that have taken place over a given period of time. Past performance is not indicative of future results. Index performance is not representative of fund performance. See disclaimers at the end of this presentations.

• The U.S.’ “CNY stability” demand is in contradiction with fundamentals (slower growth, smaller current account surpluses)
• Renminbi appreciated a lot relative to regional peers and other reserve currencies in the past several years

2 4 6 8 10 12 Mar-00 Feb-01 Jan-02 Dec-02 Nov-03 Oct-04 Sep-05 Aug-06 Jul-07 Jun-08 May-09 Apr-10 Mar-11 Feb-12 Jan-13 Dec-13 Nov-14 Oct-15 Sep-16 Aug-17 Jul-18 Current Account Balance (% of GDP)

Past Current Account Surpluses Have Disappeared

60 70 80 90 100 110 120 130 140 150 160 Real Effective Exchange Rate (3/31/2005 = 100)

CNY Levels Contracted with Fundamentals

JPY EUR USD GBP CNY

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• notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and

cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck. All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining

• market. Past performance is no guarantee of future results.

Disclosure

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