China’s ruling Communist Party held its 19th national congress in October 2017, during which President Xi Jinping was appointed to his second five-year term and confirmed as the most influential leader in decades: his political philosophy was enshrined as part of the Communist Party constitution’s “guiding ideology,” an honour shared only with Mao Zedong and Deng Xiaoping.
The congress’s economic implications are just as profound as the political ones. The party adapted its mission statement from seeking the fastest possible growth toward a higher-quality, more sustainable kind.
“It’s not your father’s China: cheap, crappy manufacturing for export,” says Andy Rothman, a former U.S. diplomat who is now an investment strategist at Matthews Asia in San Francisco. “It’s now a consumer-driven place based on rapid income growth, low household debt and high savings rates.”
Rothman points to real retail sales growth of 9.3% in the first three quarters of 2017, compared to 2.1% in the U.S. Two-thirds of economic growth came from the consumer part of the economy over that period, up from about 40% a decade ago, he says; massive real income growth makes China “the world’s best consumer story.”
While China has a much-discussed debt problem—total borrowing was at roughly 260% of the economy’s size in 2016, according to Bloomberg Intelligence—Rothman says the debt is based in the corporate sector due to state-controlled banks lending to state-owned enterprises in response to the financial crisis. Chinese consumers, on the other hand, have low household debt and high savings, he says.
It’s still not the easiest place to invest in, though, and Rothman makes the case for active management. In November, not long after the party congress, the government announced a number of reforms to open China’s closed investment sector. What follow are key facts for understanding the Chinese market.
Official name: People’s Republic of China
Government type: Communist state
Population: 1.4 billion
Head of state: President Xi Jinping (indirectly elected by the National People’s Congress for a five-year term)
Currency: renminbi (RMB) or yuan (CNY). The renminbi, meaning “people’s currency,” is the official name given to the currency when the People’s Republic was founded in 1949. The yuan is the name for a unit of the currency. So while something can cost 10 yuan, it can’t cost 10 renminbi—though you’re paying for it in renminbi. In Hong Kong, the Hong Kong dollar (HKD) is used.
Citizenship: via parentage only; no dual citizenship permitted
Income tax rate: 25%
Branch tax rate: 25%
Capital gains tax rate: 25%
Enterprise income tax: normally 25%, with special rates for small businesses (20%, or 10% if they meet certain requirements), those with High and New Technology Enterprises (HNTE) status (15%), and for certain regional activities.
Real estate tax: 1.2% of the assessed value, and 12% of rental income (may be reduced to 4% for residential)
Land appreciation tax: charged in four bands, ranging from 30% to 60%, depending on the percentage of gain
Personal income tax applies to expatriate employees of Chinese companies and employees of foreign companies resident in China.
Income tax rates: seven progressive tax rates between 3% and 45% on wages; five progressive rates from 5% to 35% on business profits
Basis: worldwide income
Capital gains: 0% to 20%
Inheritance or gift tax: none
Source: Deloitte’s “Taxation and Investment in China 2017” report
GDP (purchasing power parity*): US$21.29 trillion
GDP growth: 6.8%
Inflation rate: 1.8%
GDP per capita (PPP): US$15,400
Unemployment rate: 3.95%
GDP by sector
*PPP is the more accurate measure as China’s exchange rate isn’t determined strictly by market forces.
Source: IMF, CIA
Mainland China has two stock exchanges, one each in Shanghai and Shenzhen. At the Hong Kong Stock Exchange, foreigners can buy and sell shares issued by Chinese companies. Access is more limited in Shanghai and Shenzhen, where companies based in mainland China are listed. The government is also more involved in the mainland exchanges (it has ordered companies and funds to buy stocks during downturns).
The mainland exchanges list both A and B shares: the former in renminbi and the latter in foreign currency (USD in Shanghai, HKD in Shenzhen). A shares were traditionally closed to foreign investors, for whom the B shares were reserved. In 2001, the government opened the B-share market to individual Chinese investors and, in 2003, the A-share market opened to some foreign institutions.
Chinese state-owned enterprises are listed in Hong Kong as H shares.
The Qualified Foreign Institutional Investor program launched in 2002, allowing licensed foreign institutional investors to buy and sell A shares within a quota based on the firm’s size.
In June 2017, index provider MSCI added Chinese A shares to its MSCI Emerging Markets Index.
China has been opening its stock market to foreign investment enterprises (FIEs)—Chinese companies with foreign investment—as well as to foreign investors. For FIEs to be listed on a mainland market, they must be converted into foreign investment joint stock companies. This means the company must convert its registered capital into its stock, divided into equal shares represented by share certificates.
The Shanghai Stock Exchange has the largest market cap of the three exchanges, at about 33 trillion RMB.
In an essay posted on the People’s Bank of China’s website in early November, bank governor Zhou Xiaochuan warned that high leverage is making China’s financial system more vulnerable. He called for reduced restrictions on non-Chinese financial institutions and relaxed capital controls.
President Xi Jinping has also made controlling financial risks through regulation a top priority. To those ends, there have been recent rule changes.
- In November, China removed foreign ownership rules for several financial subsectors. Foreign companies can now own:
- 51% in securities ventures and fund managers, up from 49%. The cap will be eliminated three years after the rules come into force.
- 51% in the insurance sector within three years; the cap will be eliminated after five.
- Regulations will come into force in June 2019 that will prohibit asset managers from promising investors a guaranteed rate of return. It will also require them to put aside 10% of management fees as risk provisions.
Matthews Asia’s Andy Rothman says that while his firm manages about US$31 billion, almost 30% of which is in China, it owns shares in only about 100 Chinese companies, 87% of which are in the consumer and services sectors.
It takes a “tremendous amount of due diligence” to mitigate the risks in the Chinese market around fraud, he says.
While the government has started cleaning up bad debt, some of the exposed banks will see pressure on profitability. But investors shouldn’t necessarily write off the entire sector, Rothman says, as some banks are “extremely profitable,” responsive to shareholders, and not at risk from the clean-up process.
While “the overwhelming majority of financial institutions are controlled by the state,” there are more private companies entering and driving some innovation, though they remain small players, he says.