3 Macro Themes to Know About China as an Investor

The past few weeks have been brutal for Chinese companies and many investors’ conviction in the Chinese stock market is shaken. As a past student of China Studies in English (a legit A level subject haha) and someone with roots and family in Shanghai, I present a macro view on China and share my thoughts on what it means for investing in China.

CCP Holds Ultimate Authority

To understand the future you have to know its past. China’s cardinal principle is that the country is safe and prosperous only when the centre is strong. It has been this way since the ancient dynasties, with the Forbidden City located at the physical and symbolic centre of Beijing.

This principle is still present today, albeit less prominently. There has been a move towards a more participatory form of government, allowing provincial elections and intra-party democracy. However, the Chinese Communist Party still holds the final word. Anyone who behaved in opposition to the values espoused by the central authority risked disappearing, even big movie stars like Fan Bingbing.

➔ What does this mean for investing in China?

• Counterparty risk will always be there for Chinese stocks
• The CCP is the most powerful institution in China and won’t allow any tech giants or private monopolies to amass the amount of power that threatens its position

Rule of Law is a Work in Progress

Historically in China, the man is bigger than the office. The Emperor is seen as heaven’s representative on Earth — also known as 天子 or son of heaven. His decree holds absolute authority and overrides everything else. Anyone who defies his orders faced nine familial exterminations or 株连九族. This has resulted in the lack of strong governance institutions and rule of law.

Since 1979 when Deng Xiaoping established the “open door” policy to welcome foreign trade, the legal system transformation started to support economic growth. Today, the legal environment is more stable compared to the Mao Zedong period, but it is in development and still has a long way to go.

This is evident in the recent regulation of the online education sector. In 2019, the sector received 15,000 complaints due to irresponsible closure of over 1,200 private schools that siphoned away exorbitant fees that parents and students paid for. In the ultra competitive education system of China, these schools took advantage of the anxiety and stress, charging high fees while not always delivering on quality.

The reason for this is due to the lack of a robust regulatory framework in this sector. Rather than being a “crackdown” like what many western media is headlining, I believe this is putting in place safeguards that should have been there to protect the rights of students and parents.

➔ What does this mean for investing in China?

• Expect more regulations and hence volatility in the short term (1–3 years), because the Chinese legal system itself is also transforming to respond to the dynamic development of China
• It has only been a short 40 years for China, while the western world has taken hundreds of years to shape and define their legal system today
• These regulations are not meant to shut down the industries completely but to promote social and economic well-being in the long run i.e. short-term pain for long-term gain

China’s 14th Five Year Plan: Focus on Quality

So what social and economic goals does China have? The CCP issues Five-Year Plans to outline its strategies and priorities every 5 years. If you’re investing in China, it is helpful to be aware of them.

The latest 14th FYP (2021–2015) was released this year. An insightful summary can be referred here. I highlight 3 key points that interested me the most:

1. Prioritising quality of growth rather than quantity of growth

• No concrete targets of GDP like before
• The highest number of chapters in the FYP were related to economic system and market reforms (14%), which includes diffusing financial risks, increasing positive benefits for society and environmental protection

Source: Mercator Institute for China Studies

2. Building China into a self-reliant technological and manufacturing powerhouse

• Target >7% annual growth in R&D spending, encouraging businesses to invest in R&D through tax incentives
• Target core digital economy industries to take up 10% of GDP from 7.8% now
• Special mention to build independent semiconductor capability: 1 trillion dollars of funding set aside to invest in third-gen chips
• The word ‘digital’ is mentioned 80 times compared to 5 times in the last FYP
• The word ‘security’ is mentioned 177 times, the highest mentioned term
• Innovation and technology projects shifted up in hierarchy, with an emphasis on practical applications in different industries

Source Mercator Institute for China Studies

3. Anti-monopoly and anti-unfair competition law enforcement

• “We will persist in encouraging competition and opposing monopolies, improve the competition policy framework and build a competition policy implementation mechanism” [source]

➔ What does this mean for investing in China?

• The CCP is willing to accept slower growth for greater social and market benefits
• Chinese companies must focus on data privacy while avoiding inorganic monopolistic behaviour
• With clearly specified targets for R&D, innovation remains as a key theme because it raises productivity level and expands the Production Possibility Frontier, the next phase of transitioning to a knowledge-driven economy

Concluding Thoughts

In the last 2 decades, China pursued “growth at all cost”, achieving double digit growth rates that astounded the world. Tech giants like Tencent and Alibaba grew freely, embarking on many acquisitions.

Along this journey, the Chinese legal system and regulatory bodies were falling behind the pace. Private corporations began to hold greater economic and social clout that began to threaten the CCP’s authority. In my view, recent events are long-due government responses that were missing in the first place.

At the end of the day, these corporations play an important role in bringing about technological breakthroughs, highly skilled workforce and global exports of goods and services. Look at the 3 Chinese digital economy giants — Baidu, Tencent, Alibaba — their recent foray into the semiconductor business is fully aligned with the national strategy. Compared to inefficient state-owned enterprises, these private companies support the CCP’s ultimate goals of prosperity and influence on the global stage.

Unruly growth threatening its position is what the Chinese government wants to rein in. This may hurt the bottom line in the short term, but I’m optimistic that it will foster better partnership and cooperation between the public and private sector. This is an important foundation for long-lasting progress of any country.