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Blue Chip Journal - June 2019 edition

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FOREIGN INVESTMENT

FOREIGN INVESTMENT Betting on red Weighing up China as an investment destination 24 www.bluechipjournal.co.za

FOREIGN INVESTMENT The rapid rise of the Chinese economy over the past 20 years is quite remarkable. From being an economic backwater a generation ago, China has become a global powerhouse of manufacturing, largely thanks to its relatively lower wages and highly productive workforce. Despite this strong economic growth, however, most foreign investment in China has been through direct investment into physical assets, like factories and assembly plants, while financial investment into Chinese equity markets has been negligible. The reason for this is that a large segment of Chinese investment markets is closed to foreign investment, and the segments foreign investors can invest in are tightly regulated by the Chinese government. Global investors therefore approach investment opportunities in China with some scepticism. But many of these restrictions are being relaxed, and as China continues to grow the question has become whether it is becoming a more attractive investment destination. An investment-worthy destination should provide investors with strong growth prospects on their investments, a transparent and efficient market and the protection of property rights. Below we’ll consider some evidence regarding how China is satisfying these requirements. Positive demographic trends China has over 1.4-billion inhabitants, making it the most populous country on the planet. To put this into perspective, China’s population exceeds the secondmost populated country, India, by the entire population of Germany. This population is becoming increasingly mobile and participative in the Chinese economy. There has been rapid growth of the urban Chinese population over the last 10 years. About 800-million Chinese, or 57% of the population, currently live in urban areas, and another 350-million are expected to migrate to urban areas within the next 20 years. Despite the national population growing relatively slowly, there is massive movement of people from poorer rural areas to richer, more dynamic urban areas. The education levels within the Chinese populace are also increasing, with the Chinese government spending over USD700-billion on education every year. Their investment is bearing fruit, whereas only one-million out of 160-million (0.63%) Chinese between the ages of 56 and 65 years have graduated from university, around 26% of the millennial population (aged 25-35) have graduated. Chinese consumers are also getting richer. Where 17% of urban households were identified as being upper middle income or affluent with annual incomes of R230 000 or above in 2012, 63% of the population is expected to fall into these groups by 2022. The combination of a rapidly urbanising population, with higher levels of education and disposable income, suggests massive growth in demand for more sophisticated consumer goods and services, and for the companies that cater to these needs. Economic resilience The Chinese economy is the second largest in the world after the United States, generating about USD11.2-trillion in output every year, and has shown astounding resilience in its ability to grow at high rates despite its large size. Consider this: to generate growth rates of 6-7% today, the Chinese are adding the equivalent of the entire South African economy to their GDP1 every five months. One of the reasons they are able to achieve this is because they still lag developed nations on a relative per capita2 basis. While Chinese GDP per capita is growing around three times faster than US GDP per capita, Americans still generate around seven times as much economic output per person as the average Chinese every year. In fact, China is only now catching up to South Africa in terms of GDP per capita. Moving up the value chain Chinese products haven’t historically had a reputation for quality. Instead, China has typically been seen as more of an assembly plant of goods designed in developed nations and therefore an adopter of foreign technology rather than an innovator. This is changing, with Chinese manufacturers moving up the value chain and producing more advanced, higher-quality products. Evidence of this can be seen in the number of high-tech firms listed on Chinese stock exchanges. Some 60% of the firms listed on China’s second-largest exchange, the tech-heavy Shenzhen Stock Exchange, operate in high-technology industries. Of the 20 largest high-technology firms by market capitalisation in the world in 2013, only three were Chinese. By 2018, this number had grown to eight. Chinese companies now spend more on research and development than all firms in the European Union combined. Market penetration Foreign ownership of capital is tightly controlled by the Chinese government, with the limits varying depending on the importance of an industry to national interests. Consequently, Chinese equities are divided into different share classes depending on where the shares are traded, and who can buy them. The two most common types of shares are A-shares and H-shares. A-shares are companies www.bluechipjournal.co.za 25

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