Jeremy Glaser: For Morningstar, I am Jeremy Glaser. We are hearing a lot about a slowdown in Chinese growth, but just how steep will this slowdown be and what's the composition of it? I'm here with Dan Rohr. He is an analyst at Morningstar, and he has looked very closely at this issue.
Dan, thanks for talking with me.
Daniel Rohr: My pleasure, Jeremy.
Glaser: So, certainly there does seem to be a consensus building that these previous levels of Chinese growth just weren't sustainable and that we're moving into a period of slower growth. But there is a lot of discussion about whether that's going to happen very rapidly and very suddenly or if it's going to be more subdued over long period of time. What's your view? Where do you see Chinese growth during the next, say, five to 10 years?
Rohr: Without question we've seen Chinese GDP growth slow considerably over the past several quarters; so, in the third quarter, it's running at 7.4%, if you trust the official government numbers. And that's down from an average of roughly 10% over the past 30 years. So, no question China has slowed.
There are a lot of metaphors that get tossed out in an effort to frame the discussion, to describe the nature of the slowdown. So, you hear the hard landing versus soft landing debate. Maybe this is just a bump in the road or just growing pains. I think emerging consensus on the matter is what we're looking at here is a soft landing, and then an acceleration up to roughly 8.5%. So, I'd like to say it would seem that 8.5% is the new 10%. And implicit in that consensus view is that the slowdown we're seeing is a cyclical phenomenon. I would tend to think that the nature of the slowdown is more structural than cyclical. And as a result, the long-term growth trajectory from here on out is going to be quite a bit lower than that 8.5% number that seems to be consensus.
So, if I were to pick my metaphor, it wouldn't be the hard landing, soft landing or bump in the road--it would be a hangover. And the message here, I think, is that what we're looking at, the nature of the slowdown, now is a function directly of this credit-fueled investment binge that we've seen over the past decade.
Glaser: Let's talk about some of those structural problems then. What was driving kind of that 10% growth or even 8.5% growth? Why isn't that sustainable?
Rohr: During the past 30 years China has averaged roughly 10%, 10.4% something along those lines real GDP growth per annum. Basically, any economic model we have to describe the growth and predict how growth fares as a country gets richer suggest that as income levels rise, growth gets harder to do. So, the richer you get, the slower you grow.
In China that growth rate has been remarkably consistent at that 10% level, despite the country getting richer. While that growth rate on an absolute level has been rather consistent, the composition of that growth has changed markedly over the past decade. So, in the '80s and '90s, you saw consumption and investment rise at roughly similar levels. In the 2000s, the story changed completely. On a cumulative basis, Chinese fixed-asset investments, so the stuff of skyscrapers and shopping malls and stadiums, was up 233% over the past decade; Chinese household consumption, up roughly 80%.
So, the nature of the growth has changed, the quality of the growth in my view has deteriorated, and I think that has major implications for the growth we're likely to see in the decade to come.
Glaser: So, certainly China has a ton of people, though, and they need new infrastructure as they move into cities. Is this not just a boom that's reflective of that shift from people from the countryside to the city, or is it really even beyond that?
Rohr: We need to be careful when we say, "China has got a lot of people, so they need a lot." You always need to frame this in proportion to the size of the economy, right? So, yeah, they've got a lot of people, and a lot are moving into the cities. But you take a look at, say, something like a real estate, for example. While the movement into the cities has been massive, it's been remarkably consistent over the past decade. But what you see when looking at the real estate figures published by the National Bureau of Statistics is that growth in real estate additions has far outpaced the fundamental demand associated with the influx into urban areas.
So, just to put some numbers to it, this year China is on pace to add twice the amount of urban residential floor space as it did in 2006, despite the inflow of migrants being exactly the same and 3 times as much as it did in 1997, despite again the population change in the urban areas being consistent.
Glaser: Certainly the government doesn't want to sit idly by as the economy starts to grow at a slower rate. What kind of policy options do the Chinese have right now, and would you expect to see more stimulus spending or more of an effort to get back to that old growth rate?
Rohr: This is an interesting question because when we hear our companies, the companies we cover whether it's in my sector, basic materials, or industrials or consumer. On the third-quarter earnings call there seems to be a lot of hope placed on Chinese stimulus being just down the road. And I think when we listen to what the elite within the country have been saying in speeches whether it is the political elite or the academic elite, they are not so enthusiastic about a renewal of the '08-'09-type stimulus, where you saw huge surge in investment in infrastructure, and whatnot. They are very wary of the risks associated with going down that road again. Stoking inflation, a lot of that bad debt gets created, things of that nature.
So, I'm not so sure we're going to see another stimulus, and if we do it's going to be dramatically smaller in magnitude than the last go around.
Glaser: What are the investment implications of this?
Rohr: Well, the investment implications are beginning with a very different composition of Chinese growth. So, whereas Chinese growth over the past decade was very investment-intensive, going forward one way or another, growth in the decade to come is going to be increasingly consumption-intensive. And that's going to change how you want to orient your portfolio. So, valuation considerations aside, you'd be looking for more consumer-oriented names at the expense of say some of the names that I cover in the mining space. I would particularly avoid some of the high-cost miners that can prosper mightily when China is building a lot of skyscrapers, ever more and more, but can prospectively run into trouble if activity slows down there.
Glaser: Dan, thanks for sharing your great research with us today.
Rohr: My pleasure.
Glaser: For Morningstar, I'm Jeremy Glaser.
