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Under the Banyan Tree – A business cycle with Chinese characteristics
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Herald has returned from his summer holiday to a new buzzword in Chinese economics: “anti-involution”. Fortunately, Chief China Economist Jing Liu is on hand to explain what it means.
Disclaimer: https://www.research.hsbc.com/R/101/dGRXDLn
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Transcript
Introduction and Podcast Details
00:00:01
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto today's show.
00:00:24
Speaker
This podcast was recorded for publication on the 14th of August by HSBC Global Investment Research. Analyst certifications, disclosures and disclaimers must be viewed on the link attached to your media player.
Asian Markets and Economics with Harold van der Linde
00:00:45
Speaker
Hello from Hong Kong and welcome to Under the Banyan Tree, where we put Asian markets and economics in context. We're back in the studio after a summer break. My name is Harold van der Linde, Head of Asian Equity Strategy here at HABC Global Investment Research.
China's Economic Challenges: Competition, Inflation, and Tariffs
00:00:59
Speaker
but On today's show, cutthroat competition and inflation fears in China. What on earth is something called anti-involution? And how can it help to solve a critical problem at the heart of Asia's largest economy?
00:01:12
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Joining me here to help answer all these questions is Chief China Economist Jing Liu. Let's get the conversation started right here under the banyan tree.
00:01:34
Speaker
Now, a little bit of context before we begin. China is on a mission to reflate its economy and expand its domestic consumption. This is becoming increasingly urgent under the threat of ah terrorists that are being imposed on them.
00:01:46
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And it means the government needs to step in. Now, one of the key issues is intense competition squeezing industrial profits across sectors.
Exploring 'Anti-Involution' in China's Economy
00:01:54
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major household names like EV maker BYD and online retailer JD have been summoned by the government to come to Beijing and discuss basically vicious price wars that are happening in their respective industries in China.
00:02:08
Speaker
So what is this new buzzword anti-involution that came out of it and how can that actually fix the problem? Let's bring in Jing Liu to find out. Jing, welcome to the podcast. Thank you, Harold.
00:02:19
Speaker
Happy to be here. um Anti-involution. It's a new sort of buzzword. When I came back from my holiday, I have no idea what it means. What what is it? yeah That's right. I don't think that's a natural economics word. um It's supposed to be the opposite of evolution.
00:02:35
Speaker
So it means that instead of expanding and growing an organization and economy, it's not in a very healthy stage. I think in China's current juncture, what it means is in some sectors, we see the fierce competition and unhealthy competition because many times we see the leading players might start to abuse their market power to crowd out the smaller players.
00:03:04
Speaker
That's actually not healthy for the long-term economic growth. That's not very healthy for the market discipline. We want companies to basically provide ah new products, high quality products, they could innovate instead of actually burning money just trying to squeeze out the smaller players.
00:03:25
Speaker
So it's it's sort of going against the stream, ah going against ah competition here. I mean, competition is incredibly intense in China, right? so Certain things are incredibly cheap in China because oversupply and this intense competition.
00:03:40
Speaker
I wouldn't say this is against competition. I think um probably more accurate to say this is against unhealthy ah competition.
Preventing Unhealthy Competition and Monopolies in China
00:03:50
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I don't think if one day the market will end up with only two or three ah players, they actually will still continue playing this game. Oftentimes, it will start to charge a higher price. Absolutely, yes. Right. So I think what's going on now is in certain sectors, manufacturers might even sell goods at a price lower than cost, hoping that one day they could be ah one of the few survivors and then they can start to charge a higher a amount of money again.
00:04:22
Speaker
so to get this, for me to understand this, because you could argue, hey, this is just, should be a free market, let people compete. But what you're arguing is that you have probably massive scale advantages in China That means that the larger companies can eventually squeeze out all the other ones. And if you don't stop this sort of unhealthy competition now, you end up with effective monopolies in many of these industries, whereby there's, or maybe duopolies, right? One or two companies that effectively dominate.
00:04:53
Speaker
And that means that eventually in the longer run, these companies, when they dominate these industries, they're going to raise prices. And then it will be more difficult for other companies to come in. So... What they're trying to do is to avoid overly concentrated industries in the long run. Is that is that a good way of understanding it?
00:05:09
Speaker
I would put this way. So if a company actually can be very efficient, they can still make profit, but they can charge a price lower than competitors and then they survive, that's probably fair. yeah But if they end up doing so by temporarily charge a price um much lower than their production cost through...
00:05:32
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delaying the payment to supplier, in some cases trying to boycott smaller players, then that's illegal. And on top of that, there's also cases where probably in early days, some of the local government subsidized certain companies.
00:05:47
Speaker
So in the... Fair competition, if a company couldn't survive, probably after a while it will have to exit the market. But what if local government prevent a fair competition to play out or somebody keep giving them money to survive?
00:06:03
Speaker
That would be a different story.
China's Deflation Challenges and Consumption Boost Efforts
00:06:04
Speaker
yeah So in a sense, you have like in Europe and the US s have anti-dumping rulings, for example, which are kind of a reflection of this as well. You want competition, but you don't want people to compete at ah prices below cost to distort the market in a sense, right? Yes. that's And that's what they try to avoid. good why Why are they doing this right now?
00:06:24
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Well, I think several reasons. Domestically, we have seen the deflation going on for a while, especially for the producer price. It has been the longest contraction.
00:06:36
Speaker
So um that's a concern because that means corporate earnings are low. And at the same time, it could actually translate into this mentality. Why don't I wait for later to make my purchase? And then it could be a vicious circle. Yeah, I was just thinking about this because it could ah dismantle or undermine their efforts to grow consumption because if I'm a consumer and I think that the products are cheaper even tomorrow, then I'd rather wait until tomorrow.
00:07:05
Speaker
So you start to delay consumption, right? And that's actually but also what they want to avoid, right? yeah So to put this in and in a bigger sort of context, this is part of an an idea to reflate the Chinese economy further. is that Is that right? That's exactly right. By upholding the a fair competition rule um in a hope that um the whole economy can enter into a more healthy stage and reflation.
00:07:31
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And another thing I want to ah mention is that now we're in the environment of a lot more uncertainty externally. And we can see that the pressure is not just from the U.S., but also from EU and other trading partners.
00:07:45
Speaker
Or saying, to some extent, China need to rebalance its economy. So this is also an effort to rebalance the economy. oh That's a good way to think about it. That's ah that's right. So it made sense for them to to do so at the moment.
00:07:58
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um What I would suggest now is we're going to take a quick break and then we're going to look at some of the implications for markets and equities as well.
Supply-Side Reforms and Industry Consolidation in China
00:08:16
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So we're back from the break. We have a bit of an understanding what anti-involution is now. It's effectively, I would say, industry consolidation 2.0 because they tried something like this in the past, I think 10 years ago with steel and cement to consolidate these ah industries to a certain extent, to have normal price behavior in these industries, but also to avoid in the longer run to have one or two companies to dominate these industries so that not just the bigger ones are going to eat away all the smaller fish, if you want to put it like that,
00:08:44
Speaker
But maybe more importantly, it's part of an attempt to reflate the economy to avoid further deflation. Now, is that a fair description, Jing? And what are the implications for growth and and other particular sectors you think that are really going to be impacted as well?
00:09:00
Speaker
Yes, indeed. That's a fair description. And I want to mention probably the difference between now and 10 years ago is that we see China actually has done quite some preparation in introducing a more ah better institutional setup.
00:09:16
Speaker
You may remember the so-called supply-side reform um introduced in 2015, 2016. 16, 16, some of that, yeah. Right. ah There's quite some elements similar to this. There's also this round of capacity reduction, as you mentioned, in steel and and coal.
00:09:34
Speaker
I think the key difference between this time and last round is that there's a lot more emphasis on the market picking the winners, meaning that China has improved the institutional setup by enacting the private economy promotion law amending the anti-unfair competition law and also even introduce some new regulation trying to rein in the government behavior. um So um I think yeah this is a difference. The similarity is that, as you mentioned, whenever we see the industrial consolidation, it's usually negative for growth in the near term. So we see China's effort to ah rebalance the economy
00:10:14
Speaker
always come together with so demand boosting measures. So for example, we hear China announces 1.2 trillion mega dam in Tibet.
00:10:24
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um That's probably just the beginning. And we will see more projects being introduced, including urbanization. We also see China introduce ah child care, elderly care, those kind of public service side boosting.
00:10:39
Speaker
So I think it's going to be a comprehensive package on one side, cut capacity, reflate the economy. On the other side, are trying to boost the demand. Yeah, and confidence for people to spend. For example, as you mentioned, elderly care and these sort of things are some of the reasons why people still save a lot of money, right? They want to make sure that they can get through their old age in ah in a decent state.
00:11:01
Speaker
So that that allows them to consume more and that's what this policy tries to do. But what I find interesting here is that it will probably be negative on growth. And if I would ask you, where's GDP growth going to be, ah say, over the next couple of years, you're probably going to see continued trending down. I mean, it started at 10 percent, but was it 15 years ago? More than 10 percent. More than 10 percent, yeah.
00:11:23
Speaker
So we we gradually go down. And this is just another sort of adjustment process China. Our forecast for this year is 4.9%. Next year is 4.6%. Obviously, there's internal, external factors behind it.
00:11:38
Speaker
um I think probably it's time to switch gears and ask the question, what's the impact on the equity market? So I think the impact on equity markets is really interesting because ultimately equity markets, stock markets is a bunch of listed companies.
00:11:54
Speaker
People always think about it's a sort of reflection of the economy. It isn't. It is basically just a bunch of listed companies. So it's a prospect of these companies. And if we see industry consolidation, this is actually good for these companies.
00:12:08
Speaker
We are now in a situation where most markets are incredibly competitive. And we see some consolidation. The property market is a prime example of that. But you see this in electric vehicles. We see this now in solar as well and a whole range of other industries.
00:12:23
Speaker
This is good for profitability. So we're going to have a funny sort of disjunction, I suspect, between equity market performance and economic growth. You're talking about your GDP growth numbers for next year being lower than than this year.
00:12:36
Speaker
I think in the next couple of years, there's a good chance that profitability in China is going to improve. Because we see consolidation and therefore pricing power starts to come back. And also what we've seen with Chinese companies that they manage their balance sheets much better. They're giving out dividends and they do share buyback. Something that 10 years ago people would laugh at if you would mention that. That's probably the necessary structural transition, not just for the sake of high speed growth, but more quality growth and more balanced growth. Yeah, and exactly. And so they want maybe low growth, but higher quality. And a good thing is that the high quality names are listed on the stock market. So for them, there is ah more to go.
00:13:17
Speaker
But if you just look at the dynamics in industries, we have such intense competition and such weak demand that under normal circumstances, economic theory tells us you need to see a consolidation in those industries because not everybody can survive. And the companies that are smallest and the highest cost level, they will typically not be able to compete anymore.
Government Regulations and Economic Adjustments
00:13:39
Speaker
And we started to see this sort of industry adjustment processes already, in particular in EVs, I think is the clear example, that Now the government has stepped in with this anti-evolution sort of regulations to to guide this particular process. But I think the underlying process is just a very normal sort of micro-economic adjustment, to if you want to put it like that, of of of how industries respond. yeah Well, I think that's actually how the business cycle works, right?
00:14:06
Speaker
Usually we see a lot of companies try to go into a profitable business and then it becomes too crowded and all of a sudden the demand starts to weaken and then we go through this consolidation and then go up again.
00:14:19
Speaker
Exactly. It's a normal business cycle with Chinese characteristics, if you want to put it like that, with the with the policymakers trying to um to influence in in a way that they... With the hands more visible than other markets. With the hands more visible than other markets.
00:14:34
Speaker
Thank you very much. Jing. Unfortunately, that's all the time that we have got to for today. Thanks very much for joining us this week. And remember to subscribe to Under the Banyan Tree, wherever you got your podcast. And that now includes YouTube.
00:14:47
Speaker
My regular co-host Fred returns next week. We'll be back then. Take care for now.
00:15:09
Speaker
Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes.