Investment Adventures in Emerging Markets

Will China’s New Leaders Rise to Reform?

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While the uncertainty wrought by the election process in democratic countries may be largely absent in China, the country’s gradual transition to new leadership and the likely new course for the country over the next decade still raise questions. In March 2013, the National People’s Congress, China’s parliament and highest state body, intends to formally usher in China’s leadership, and some members of the “old guard” are retiring. The question on my mind is: Will China’s new leaders continue to reform the economy, moving it toward a domestic consumption model, and still be able to maintain enviable growth rates?  I believe the answer is yes.

Behind China’s Closed Doors

The once-a-decade leadership change in China takes place under very controlled and secret conditions. It’s not a process involving the entirety of the Chinese population since the Communist Party stands at the towering heights of the economy and the government organization.

Within any political party, there will be differing opinions on the best way to direct the economy and implement policies, and that’s certainly true in China, too. But the Chinese process is generally peaceful, and I expect the new leaders to quickly move past differences and on to developing and implementing the “Five-Year Plan,” a road map for the country’s future development.

The Five-Year Plan

China’s current Five-Year Plan aims to transform the Chinese economy from an export-led model into a domestic consumer-led one. It’s a transition with implications for the entire world. Part of this process involves a slowing of China’s growth rate from the double digits of years past. We believe a slight moderation was inevitable due to the sheer size of the economy (now the second-largest single economy in the world).

This past year, there was much discussion surrounding a possible “hard landing” in China, an abrupt slide in its growth rate amid a challenging global environment. I’ve held steadfast in my view that China’s growth could continue to fly—and that appears to be the case. Notably, in November, Chinese Commerce Secretary Chen Deming indicated that the country is expected to meet its official GDP growth target of 7.5% in 2012, hardly what one would consider a hard landing.  If the U.S. and Europe can forge meaningful progress on their debt problems and if global economic growth rebounds, I would not be surprised to see China gain even a bit more altitude. But even if its growth were to stay the same or even slow to 6% or 7% next year, I think that could still be regarded as a very fast rate.

Reform and Progress March On

Xi Jinping is the new head of the Communist party in the People’s Republic of China, and Li Keqiang is second-in-command. Both publicly emphasized the need for continuing reforms, but Mr. Xi is a conservative and viewed as more reform-minded on the economic front than on the political. Revolutionary policy shifts from China’s current course don’t seem likely. Among the reform efforts, most encouraging is a push to crack down on corruption and an effort to have a wider distribution of the wealth.  Many observes expect the focus of urbanization to transform large cities into smaller cities, a situation in which city registration system reforms could take place. Environmental protection is likely to be another focus, and natural gas will likely play a bigger role in China’s energy sector.

As mentioned, the Five-Year Plan calls for a transition to high value-added manufacturing as well as development of a stronger domestic economy to replace the export-led economy of the past.  Wages in China are already on the rise, and more money in the pockets of consumers typically results in increased spending. Meanwhile, China is gradually reducing its dependence on exports. The new leadership has the job of continuing to turn its huge population into a more consumer-oriented society, so China is less dependent upon exports as it grows.

Increased productivity is a critical part of this evolutionary process. When we look at the makeup of China’s exports, we are seeing more and more high-tech goods. I’ve seen a vast improvement in quality at the factory level in China. Autos, telecoms and other high-tech companies are improving their goods to compete on the global stage.

Foreign Relations

This period is a critical time for China’s new leaders in terms of their attitude toward foreign relations. There are concerns, such as the dispute with Japan over the islands in the South China Sea, and the fact that, as the United States’ second-largest trading partner, the U.S.-China relationship requires a deft touch.  This new leadership is young, modern and seems to be quite flexible, which I believe should bode well for this important relationship.  At the same time, with President Obama re-elected to a second term in the U.S., I think we could see a more conciliatory foreign policy.  With two leadership groups who seem willing to accommodate and negotiate, my prognosis for the relationship is generally positive.

This historic shift is fascinating, but of course all our research and evaluation come back to the bottom line of investment opportunities. No matter who is in charge in China, I see its consumer culture continuing to grow, and I believe the demand for commodities, products and services should continue to grow with it, stoking the engines of growth for some time to come.

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