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What can we expect in China in 2020?December 2019By Gordon OrrWith domestic consumption powering economic growth, companies should consider stepping up their activities in 2020. Introduction2019 in China brought together long running challenges, such as uncertainty over US-China tariff levels and ever more intrusive regulation of business in China, with a few unexpected ones as well: the crisis in Hong Kong and the flare up triggered by tweets from an NBA coach, to mention just two. Yet for many businesses, opportunities flourished throughout the year as Chinas economy grew roughly 6 percent. And in multiple key industries, the governments commitment to global leadership started to pay dividends. 2020 will offer a similar mix of evolving, often worsening, challenges. Growing separation between the US and China in technology sectors seems inevitable. While some companies will evolve to remain relevant in both markets, others will choose to focus on one. In 2020 this separation may become broader, impacting financial markets much more directly. Chinas economic momentum will continue in 2020 with domestic consumption leading the way, selectively creating opportunities. If Chinas priority sectors match those of your business, 2020 will be a good year to step up as the taps of government funding remain open for now.US-China relationsMultiple areas of growing separation between the US and Chinese economies predicted in last years note were largely realized investment flows, supply chain, data flows, people flows, technology procurement, standards. In all these areas, further separation will occur in 2020. One example, US government agencies, such as the National Institutes of Health and the Department of Energy, not just the Department of Defense, have been presenting US university administrators with hundreds of case examples where they believe non-US academics, largely Chinese, have failed to disclose parallel funding for their research from overseas governments along with commitments to share their IP discoveries with those governments. Those academics will likely be proactively excluded from US universities; many others will self-select out or simply not come to the US in the first place. Restrictions on investment from China into the US will shift from a focus on larger deals, which have shrunk to almost zero, to direct and indirect (i.e. through funds) investment into technology startups. I did anticipate a year ago that we would have clarity about tariffs by now, not the ongoing uncertainty that holds back investment plans in supply chain and factories. Looking into 2020, if there is finally agreement it seems likely to be narrow and not likely to be long lasting. Multinationals have suffered least from tariff volatility. They typically send no more than 15 percent of their China production to the US and have multiple factories around the world that they can move production for the US to. Almost none of these factories are or will be in the US. Smaller businesses, often foreign-owned, that focuses solely on exports to the US, have been most hurt. Factories do continue to move out of China. Manufacturers are also consolidating in China, doubling down on technology in their remaining factories. Indeed, China is rapidly becoming the world center for the Internet of Things in factories. These trends preceded the US tariffs and have only been marginally accelerated by them. More non-Chinese companies than Chinese are shutting down factories in China, but not all move production out of China as they close. A good number outsource their manufacturing to a Chinese owned company producing in China, believing that the Chinese company will be lower cost than the foreign-owned factory, and just as good quality.New areas of US-China separation will come into focus in 2020. Financial markets will be front and center. The U.S.-China Economic and Security Review Commissions 2019 report to Congress has as its first recommendation to delist Chinese companies on US exchanges that do not meet four criteria. No Chinese company listed in the US meets all four, many wont meet any. This threat covers 2 What can we expect in China in 2020?around 500 companies with a cumulative market capitalization of about US$ 1 trillion (dominated by Alibaba). It was smart of Alibaba to get its secondary listing in Hong Kong in place in November 2019. Companies such as Ping Ans fintech subsidiary, OneConnect, which has announced plans to list in New York, may reconsider. After all, less than US$2 billion has been raised by Chinese companies on the NYSE and Nasdaq so far this year, down 74 percent from last year. Some Chinese tech companies may list domestically within China where listings generally achieve higher earnings multiples and Chinese regulators have quietly made it possible for companies using the Variable Interest Entity (VIE) structure to list domestically. Technology tensionsThe US and Chinese governments continue their rush to embrace greater technology separation. 2020 may be a tipping point. On one side the US government excludes Chinese companies from buying US sourced technology components (at least from being able to do so with certainty), from investing in US technology companies, and from supplying their technology products into the US. On the other, the Chinese government has launched an over US$20 billion fund to support Chinese independence in a broad range of manufacturing technologies to go alongside its similar sized fund to support developments in semiconductors. Chinas “secure and control” initiative is encouraging government departments and state-owned enterprises to buy technology without US content perhaps 25 percent of the traditional PC and server market. Chinese manufacturers share of the server and storage market had already risen from around 30 percent in 2012 to 70-80 percent in 2018. It is set to rise higher. In smartphones, four Chinese brands hold more than 85 percent of the Chinese market and less than 1 percent of the US. Chinas internet giants, with the exception of TikTok, are absent from the US (TikTok may not retain its presence in the US for long if US legislators sustain their focus on the company); the US giants have long been absent from China.The pinch point in semiconductors of Taiwanese contract manufacturers who play a key role for both US and Chinese companies will become much more visible in 2020, with greater levels of government to government pressure exerted on the key companies. One of the few business-focused outcomes from the recent 4th Plenum were plans to establish a “new national system for making breakthroughs in core technologies under socialist market economy conditions.” This feels very similar to state-driven industrial policies contained in “Made in China 2025”, if not yet with the quantitative targets. In some areas, China is likely to achieve goals quickly, for example, as China still represents nearly a quarter of global manufacturing output; taking leadership in smart factories should be a no brainer. China is turning its cities into large-scale pilots for 5G-enabled smart cities at a pace that will allow China to set de facto standards. Their products will not be accepted in the US, especially not as many will require access to large scale data sets that dwarf those that Chinese companies have been blocked from.All Chinese and US tariffs could be eliminated tomorrow and only have a marginal impact on these trends. Both governments have embraced growing separation, the only question is how fast and with how much pain is incurred as we proceed.3What can we expect in China in 2020?Global Sports and ChinaReactions in China to the social media post by the Houston Rockets general manager are winding down. Initial reaction to the post in China was not surprising; perhaps what was surprising was that it has taken so long for this kind of incident to happen. International criticism of China over Xinjiang and Tibet has occurred for years, but had not triggered an incident, despite sports figures taking public stances on many issues globally. The incident should make any business that takes sponsorship from Chinese companies pause. Have they done sufficient due diligence on the Chinese company to assess the risk of a player or a fan base launching a campaign against the sponsor? Multinationals with large operations in China should consider the risks of their China sales becoming collateral damage if Chinas social media nationalists decide to blame a corporate sponsor for remarks made by a team player or coach.Where might the next incident happen? Soccer. Premier League clubs regularly play preseason games in Mainland China. What would happen in China if European soccer fans waved banners in support of Hong Kong or a player made a remark on a topic deemed sensitive in China? No TV or online coverage of their games, and pressure would be put on their Chinese and non-Chinese sponsors to withdraw their support to the team. What would happen if the impacted team was owned, all or in part, by a Chinese company? (such as Inter Milan by Suning, Wolverhampton Wanderers by Fosun) While professional sports see enormous commercial potential in China, it largely remains that potential. Could European soccer leagues survive without Chinese advertisers and broadcast revenues? Yes. The NBA, the same. Some teams may have to. Consumers in ChinaConsumer retail spending in the first 10 months of 2019 rose 8 percent year on year, ahead of income growth of roughly 6 percent. Over 10 million new jobs were created. With moderate house price growth and a positive year in domestic stock markets over the last year, the wealth impact on consumer confidence remained positive. More and more consumer purchases are now financed through installment payment schemes, through credit cards and bank debt (now well over US$ 1 trillion). The average Chinese consumer is not yet overleveraged (total household debt stands at only 60 percent of GDP), but the 20-30 age group who borrow most enthusiastically are getting there, pulling forward consumption from future years. These younger age groups also sustain higher current spending by not entering the property ownership market. For many, property prices are now so high it is simply not possible until much later in life. Many realize that renting is a better economic plan. A recent JLL report showed the average price of renting in top Chinese cities was less than half the average mortgage payment. At the individual city level, these trends could finally trigger a material downward adjustment of as much as 30 percent in specific city property prices in 2020.Multiple consumer sectors suffered significant demand weakness, most notably the automotive sector and smartphones, where a 2020 rebound is unlikely. Yet many service sectors are thriving. Private education providers with quality facilities and faculty are one example, especially those with internationally focused curricula. I recently visited the brand new Whittle School in Shenzhen. With its world class facilities, it will attract students who would otherwise have commuted to schools in Hong Kong. Second tier cities, such as Suzhou, are showing that they can support multiple international schools targeted at mainland students, with Perse School from Cambridge, England adding to those present. Lego announced that it is building the worlds largest Legoland theme park in Shanghai at the cost of over US$625 million, locating it alongside Disneyland Shanghai, creating an international theme park cluster. And it has plans for many more.4 What can we expect in China in 2020?Healthier eatingChinas endless food health and safety scandals along with a growing awareness of personal health (supporting the boom in gyms in China) has led many middle-class Chinese to embrace healthier eating choices. Restaurants are adding more vegetarian options, and plant-protein based meat replacements are gaining traction. In China, which consumes more than 50 percent of pork produced globally and has seen pork prices rise over 100 percent due to disease in the pig population, the need is for pork alternatives, rather than the focus in the US on beef substitutes. As a result, Asian companies such as Green Common from Hong Kong have taken the lead in meeting this demand. The government is getting more involved, requiring manufacturers to provide additional labelling information. In 2020, the government will require that labels on foods show their glycemic index, a rating of how the carbohydrates impact blood glucose levels. The government is acting in an attempt to impact the explosion in diabetes and obesity across China. If the experience of launching this index in Australia provides guidance, food manufacturers will reformulate their products to reduce their GI rating and will market aggressively on the back of having done so, leading to a boom in consumer demand for lower GI products.With Chinas food delivery services providing more than 40 million meal deliveries a day and still growing 35 percent year on year, Meituan and Ele.me have a key role to play in shaping middle class food consumption in China. To meet this demand, they will be promoting healthier options and providing more information to consumers on their choices, whether it is lunch delivered to the office or dinner to the home. Social Credit System not a big deal for individuals yetGovernment initiatives to create social credit systems attracted a lot of international attention earlier in 2019, which has since died down. In part this was because the system was neither as new nor as all-encompassing as initially described, and in part because Chinese citizens are currently mellow about the entire scheme. Data gathered in the system comes almost entirely from existing databases compiled by many agencies covering financial matters, Party membership, regulatory and legal compliance. As much as 75 percent of this data was already publicly available, perhaps just not online. For many citizens the question was more “what has changed?” Calling out individuals who fail to pay their debts on a public blacklist, making you aware that someone you might be about to do business with has defaulted in the past, seems like a good thing. As with any system, there is potential for misuse, blacklists can get too long, and they may not be objectively created. Evidence from a Jiangsu pilot shows that if government gets too heavy handed, citizens successfully push back. And of course, there is a part of the social credit system that evaluates and black lists government departments, with more than 20 county level governments already having been blacklisted as “dishonest”.5What can we expect in China in 2020?Rebound of EVsVehicle manufacturers in China had a tough 2018 and 2019. The overall market fell 8 percent
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