The Emerging Markets Handbook. Pran Tiku

      China has so far done a good job when it comes to education and healthcare spending. It has to encourage the private sector to share in this investment so that more young people have the skills necessary to prosper in the knowledge economy, where skills need to be constantly upgraded.

      Environment

      China gets a score of 34.53 out of 100 in the environmental Bloomberg ESG rankings. Examining Exhibit 10 below, we can see that China’s low score is a result of high carbon imports, high carbon dioxide per capita and low forest area as a percentage of total land area.

      Exhibit 10 – Environmental ranking percentile

      Conclusion

      China has the worst ranking among the BRICs and needs to do a lot more to protect its environment.

      Capital markets

      Exhibit 11 illustrates the performance of the Hang Seng Index over the last 12 years. The beginning of a bull run can be seen in 2002, which coincided with the spectacular GDP growth numbers that China put up in the beginning of the decade. We then see the crash of 2008 and the emerging market rally of 2009 that took market pundits by surprise. The choppiness that we see from 2010 coincides with market realisation that China’s growth rate will slow in the coming decades.

      Exhibit 11 – Hang Seng Index (in US$)

      Data: Bloomberg

      China’s capital markets, especially its public markets, remain plagued by insider trading. The government has cracked down on this practice and has promised to reduce government involvement in approving IPOs, but its promises have yet to be backed up by action. The Chinese securities watchdog has moved to liberalise the stock market by removing the limits on investment by foreign investors.

      The public markets indices are dominated by state-owned enterprises, which in turn mostly consist of energy and financial services companies. Consumer staples and consumer discretionary only consist of 3.5% of the Chinese H-shares index, giving investors little exposure to the China consumption story.

      Exhibit 12 gives a breakdown of the H-shares Index. As seen in the chart, energy and financials which are typically state owned dominate. This share can be expected to decline, particularly in the financials sector, as the government moves towards liberalisation.

      Exhibit 12 – Breakdown of China’s H-shares Index

      Data: Bloomberg

      According to the World Economic Forum’s 2012 Financial Development Report, China ranked 20th (out of 60 countries) which was above all other BRIC countries. The ranking has seven sub-pillars that make up the overall ranking.

       China ranks best on the fifth (4th place) and fourth (17th place) pillars, which represent Non-Banking Financial Services and Financial Services respectively.

       It ranks worst on the second (47th) and seventh (41st) pillars, which represent Business Environment and Financial Access respectively.

       Its rank is pretty mediocre on the third (20th), sixth (21st) and first (35th) pillars, which represent Financial Stability, Financial Markets and Institutional Environment.

      Conclusion

      A lot more needs to be done to crack down on insider trading and improve the general level of disclosure coming from the financial statements of publicly listed Chinese companies.

      In a nutshell

      Strengths

       Massive foreign reserves to cushion a financial crisis.

       Robust increase in domestic consumption due to rapid urbanisation and growth of second-tier cities.

       Increasing adoption of mobile phones and increasing internet usage.

       High-quality infrastructure in urban centres that has removed bottlenecks for growth that still hamper emerging market rivals.

       Dominance in manufacturing and exports that has lifted millions out of poverty and created the aforementioned massive foreign reserves.

       Increasing spending on health, education and job skills.

      Weaknesses

       The risk of a real estate bubble and slowdown due to overinvestment.

       Lack of original innovation and lack of protection for intellectual property.

       Absence of a free press and freedom of speech, and a growing rich-poor divide, that could all result in social unrest.

       An increasing dependency ratio due to the one-child policy – this could put a strain on the welfare system.

       Corruption that has spread to the top echelons of the Communist Party and a display of wealth that is infuriating the public.

       Domination of state-owned enterprise and a lack of transparency with accounting disclosures.

       Lack of protection of the environment that is reducing the quality of life of urban citizens.

      Our take

      A growth rate of around 6% will be the new normal for China in the coming decade. China’s ability for original innovation without resorting to copycat manufacturing will determine its ability to emulate South Korea in going toe to toe with developed economies. The biggest unknown remains the ability of the Communist Party to meet the aspirations of its people and hold on to power. Assuming the status quo is maintained, China can be expected to continue its journey as a rising power and emerge as the world’s biggest economy.