Our regular readers will remember that we’ve been commenting on the anti-corruption programs of Chinese President Xi Jinping since shortly after he came to power in 2012. The son of a reformer imprisoned several times under Mao’s rule, Mr Xi has spent the past two years consolidating his power and going after ever bigger targets.
His administration began by allowing China’s weibo (micro-blogging platforms similar to Twitter) to out corruption among petty local bureaucrats, while keeping a lid on the exposure of national figures. He worked simultaneously at consolidating his own power — for example, centralizing control of China’s internal security under his direct authority — and gradually ratcheting up pressure on higher officials.
In March, former security boss and Politburo Standing Committee member Zhou Yongkang came under scrutiny, with billions of dollars’ worth of assets seized; Zhou himself was put under investigation in July.
Many observers now believe that Xi has more power than any Chinese leader since Deng Xiaoping, whose reforms inaugurated China’s growth in the 1980s.
On to Bigger Things: What Could This Shift Mean For Investors?
We suspected that this would mark a turning-point in Xi’s administration. With power consolidated, and with lower cadres chastened and with fear put in some of the “tigers” (powerful, corrupt officials), Xi would be able to move on to substantive economic reforms.
A September 30 meeting of the Politburo announced that its formal campaign to “improve the relationship between party officials and the general public” had “largely run its course.” Several observers took this as an official indication that the anti-corruption drive has reached its initial goals, and the Party leaders are getting ready to shift gears and prioritize longer-term strategy.
Alibaba Highlights the Potential of China’s Next Growth Leg
All of the excitement and anticipation surrounding the initial public offering (IPO) of Chinese internet titan Alibaba (BABA) has once again attracted investors’ attention to the potential of China’s middle class as an engine of growth. Since long before Xi took office, analysts have been discussing the epochal shift of the Chinese economy from intensive industrial and infrastructure investment to a consumer-led growth model. Alibaba is a poster-child for this development. Jack Ma, Alibaba’s founder, is a charismatic business leader who sees it as his vocation to support and enable the small Chinese entrepreneur. Whole villages in China now exist and thrive as a direct result of the BABA e-commerce ecosystem. And not only is Alibaba dominant in e-commerce — it is threatening to disrupt established Chinese banks with a new investment and lending model. BABA’s IPO is news that the re-orientation of the Chinese economy is underway.
We can be sure the Chinese government is controlling the process carefully — and observers of BABA’s IPO know that Mr. Ma paid his dues to many powerful economic interests in China by rewarding them with blocks of BABA shares. But in many fundamental respects, Mr Ma and the Chinese government have common interests.
Risks and Rewards
What does this mean for western investors looking at China?
Most immediately, certain sectors that have been under particular pressure from the anti-corruption drive may experience a respite. We’re thinking of the luxury goods markets. But not too fast. For example, we think that the lucrative “junket” trade, which brought wealthy gamblers from the mainland to Macau and helped them get around currency controls, may be in permanent decline. In short, while a cool-down in the anti-corruption drive may take the pressure off some hard-hit sectors, we remain skeptical that they will ever get back to their glory days. In short, the anti-corruption drive has actually been somewhat effective.
Near-Term Pain
Further, there may be some near- to mid-term pain from this fact: with corruption more under control, the government may be more willing to tolerate lower growth. If fat cat officials are out of the public eye — or better still, if the public really believes that they’re being taken down — the government may think the public is less likely to be restive at the effects of a growth deceleration.
And observers generally agree that this deceleration will be a side-effect of the government’s strategic shift to consumer-led growth. The banking system and the real estate sectors will slowly be deleveraged and brought under control, as will local government financing. Wasteful and corrupt infrastructure projects will be curtailed.
The administration of state-owned enterprises will become more independent of state policy. The hukou system, which has made migrants from rural areas to be second-class citizens in China’s cities, will be reformed.
Growth Potential
All this could cause some disruption, but we remain focused on the growth potential represented by businesses such as BABA. The rise of the Chinese middle class, and of the businesses such as BABA that this rise will encourage, is a phenomenon as significant as China’s exit from central planning and embrace of a market economy. As a matter of principle, we want exposure to this theme, which, along with India’s reforms under Modi, we view as a potential secular growth story of prime importance. (GIM clients currently own positions in BABA.)
However, we would not be undiscerning in our exposure to this theme. It will unfold in fits and starts, and we would own China tactically for the foreseeable future. We would only own those companies and sectors we see able to benefit from the shift — and only when the Chinese economic and policy environment is friendly.
Investment implications: China’s shift to a consumer-led economy will be a development of almost unparalleled significance for the global economy. While in principle we want exposure to this theme, we are currently owners of China only on a tactical basis. Investors seeking exposure to China’s internet economy and to the Chinese consumer should monitor the Chinese policy and economic environments closely. We still expect periodic financial tightening policies that will put pressure on Chinese stocks.
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