China Outlook – Navigating structural change

We understand why investors are concerned about the property sector as it accounts for a significant part of the Chinese economy. The worry is, following the longest downturn in housing prices on record, if the downward spiral between confidence and sales continues then the credit cycle will further deteriorate, and economic growth will suffer.

The challenge is how to strike a balance between boosting the property sector and avoiding fueling another asset bubble. While there is good reason for the Chinese government to be cautious in announcing a bazooka-like stimulus package that may rekindle leverage in the sector, the key now is nevertheless to deliver a clear signal with strong and meaningful support to turn around the market expectations and pull the housing market out of the downward spiral. The property sector has been instrumental to China’s economic success, but it is now set for a period of structural decline. This is largely a result of aging demographics and slowing growth in the urban population. In a nutshell, fewer houses are needed to support the population. From a long-term perspective, China needs to wean itself off the leverage-heavy housing sector and look towards a more diversified set of future growth drivers – in areas such as technology – and the further development of a more modern, self-sufficient manufacturing base.

In the near term, we do not expect an extreme downturn in the property market – we believe resources will continue to be mobilized to prevent this. For example, over the last two years, a number of concrete initiatives have been implemented to boost the ailing sector, such as lower mortgage rates, the easing of previous curbs on property transactions, and direct financing support for developers. As such, our view on the possibility of a major systemic risk to the overall economy remains low. In the medium- to longer-term, the question is whether, during the process of weaning off real estate, the country can successfully close the contribution gap between the housing market and other sectors.

Private enterprise, and particularly the services sector, lies at the core of replacing property in China’s long-term growth ambitions. In our view, the private sector has an important role to play in correcting the structural imbalances in China – with the youth unemployment situation being of key concern. In the latest disclosure from National Bureau of Statistics of China, youth unemployment stood at 21% in June for ages 16-24, a number that will no longer be publicly reported given its pessimistic implications and a proclivity to misunderstanding given China’s nuanced reporting metrics.

While government support is part of the solution here, the private sector is critical in creating not just more jobs, but higher skilled and better paying jobs that appeal to China’s highly educated, young talent pool. China’s pivot to higher-value, more innovation-driven sectors will thus be key to addressing its challenges in the labour market, while at the same time boosting productivity and treading a sustainable growth path similar to that taken by Korea and Taiwan.

Over the last couple of months, policymakers have signaled a more supportive stance towards internet platforms, an area that is dominated by private entrepreneurs and a proven strength of China’s innovative and industrious minds. Indeed, by bolstering private entrepreneurs, not only in the internet sector, but also encouraging private entrepreneurs in innovation-related areas like new energy vehicles (NEVs), green energy and technology, biotech / drug innovations, and so on, China could see scalable productivity improvements that ultimately help boost sluggish growth across the entire economic value chain. This first needs to play out in the domestic market but could later also extend into global markets, as China is able to innovate and deliver products and services that satisfy the needs and wants of an increasingly connected global population.