Authors: Philip Saunders, Co-Head of Multi-Asset Growth, Sahil Mahtani, Multi-Asset Strategist, Greg Kuhnert, Co-Head of 4Factor, Mark Evans, China Analyst, Mike Hugman, Portfolio Manager, Emerging Market Fixed Income, Professor Robert Ash, SOAS, China institute, University of London
China’s vast rural economy is the next growth opportunity
Written in partnership with the Investec Investment Institute and SOAS’ Robert Ash, who has spent his entire career thinking about rural China, this is not just a story of organic catch-up.
The significance of China’s rural economy
Investors are well aware of the urbanisation story in China. Yet it is rural China, with its over half a billion residents, that is now becoming the key engine of China’s next great transformation.
This is not just a story of organic catch-up growth but of strong policy momentum.
Xi Jinping’s administration has made China’s rural economy a priority, focusing on overall economic growth, food security and social stability, as it seeks to augment its quality of growth, not just its quantity.
- 40% of China’s population live in rural areas;
- 3,202 Taobao Villages;
- 8% of GDP is agriculture.
For investors, this is an opportunity to get involved in the take-off of Chinese consumption growth. The development of rural China is a story of integrating an economy on a vast scale. In the 20th century, the United States became a major continental trading power and the economic motor of the world, benefiting investors who rode that wave. In the 21st century, we believe investors should be laser-focused on the same transformation in China.
Politics powering China’s rural reform
China’s rural economy is vast, understudied and underestimated. Yet over the last two years, rural China has quietly become central to Xi Jinping’s reform plans, as he believes the Chinese Communist Party’s (CPC) ability to fulfil its major economic goals all critically depend on turbocharging the rural economy.
China has set out a clear timetable for rural reforms based on a new policy framework with the ultimate goal to create a rural sector exemplified by "strong agriculture, a beautiful countryside and well-off farmers".
The new framework has three pillars.
Addressing poverty among large numbers of farmers and closing the urban-rural divide
For a security-minded regime like China under Xi Jinping, national food security is essential.
Achieving environmental sustainability
Addressing farmland loss, soil pollution, water shortages and water pollution.
Meritocracy in government
Aiding China in pursuing its rural reforms is its unique system of meritocracy in government. Rural progress is now a yardstick for promoting officials. This is important because of China’s model of political meritocracy, or what some have called its 'promotion tournament model'. It is a key platform for how China has been able to achieve such impressive levels of growth since the Deng years
In 2017, 1.56 million university graduates took China’s 5-hour civil service exam, with only 27,000 jobs available.
E-commerce: driving rural revitalisation
E-commerce has become a prime engine of rural revitalisation. Explosive growth numbers already bear this out. In the four years to 2018, online retail sales in rural China increased by a compounded annual growth rate of 66%, compared to 34% nationally.1
In the fourth quarter of 2018, the growth rate of rural digital spending on Alibaba’s e-commerce platforms reached 24%, or 4.5% higher than that in first-tier cities. Recently, Alibaba has said that it is looking to make its rural strategy one of its three core strategic development plans over the next two decades, after global and cloud.
E-commerce is is aligned with China’s rural revitalisation effort. It boosts consumer spending power, narrows the income gap between urban and periphery, and augments productivity growth.
The future of China’s rural sector
Taking all of this together, we lay out three scenarios for the prospects for income growth in rural areas, each depending on Chinese reform momentum.
In the best-case scenario, rural incomes will benefit from institutional reform, sustained agricultural productivity improvements, high school and university enrolment, nutritional improvements and the growing use of e-commerce, and rural tourism.
Absolute rural-urban income gap, 3 possible scenarios:
- Optimistic: $3,159
- Base case: $10,457
- Pessimistic: $17,865
This will reduce the urban-rural income divide. In the worst-case scenario, these reforms will happen slowly, if at all, and the income gap between China’s rural and urban areas will continue to grow.
Implications for investors
Successful rural revitalisation impacts the big questions in Chinese equity and fixed income. For equities, it means a longer growth period for China’s consumer companies, faster consumption growth in the years ahead, and, of course, a tailwind behind companies attuned to the needs of rural consumers. In fixed income, all things being equal, it means a higher sustainable rate of Chinese economic growth; a higher rate of productivity growth, a lower rate of inflation and a stronger currency.
In the past, the way to convert the impressive Chinese macroeconomic story into returns has been to focus not on Chinese assets but the assets of suppliers to China. These included resource companies, resource-producing economies or exporters of capital and consumer goods. The creation of a vast, consumption-led domestic Chinese economy means the opportunity for domestic assets is where the opportunities now lie. To judge by current Chinese equity valuations, that change is not yet reflected in prices. We have explored the change in asset allocation towards China that global investors must make in our summer 2019 paper, Dig the Well Before You're Thirsty. In that paper, we suggest that based on China's size, growth trajectory and distinctive characteristics, a separate allocation to the country may now be appropriate. The country already possesses the second-largest equity market and the second largest bond market. It is by far the largest single-country contributor to global growth and, within the next decade, the Chinese economy is forecast to outsize that of the US. Given the country’s longstanding lack of representation in global benchmarks, even those maintaining their current allocation framework will be making a significant active call on China, one way or the other.
If successful, China's internal transformation, starting with its rural reforms, promises to reshape the world order in ways the West has only just begun to appreciate.