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Why invest in China?

01 May 2018 | Markets and Economy

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China graphic

As the second-largest economy in the world, China is too big for investors to ignore. Yet the nature of China's economic growth model in the past has raised questions about its long-term sustainability.

So, why China – and why now? In this article, we examine the economic landscape that makes the People's Republic of China (PRC) a potentially attractive market for global investors.

China's growing importance

The Chinese economy has grown remarkably in the last two decades, and it now plays an active and constructive role on the global economic stage.

In 1960, the economy of the United Kingdom was almost 20% larger than that of China. In 2006 China's GDP surpassed the UK's, and by 2016 the Chinese economy was more than six times larger. Between 2000 and 2016, China's share of total global GDP more than trebled, from 4% to 15%, putting it in second place, behind the United States, whose GDP share decreased from 40% to 25% in the same time frame.1

In addition, China has played an increasingly important role in international trade. In 2000, China was responsible for just 2% of global imports and exports. Those numbers have increased significantly, to 10% for imports and 11% for exports, as of 2016.2 Outbound investments relating to the PRC's Belt and Road Initiative – an ambitious (and controversial) plan to improve transportation links between China and its neighbours – could also spur the world economy and encourage economic cooperation.

Gross domestic product, 1960–2016

Gross domestic products

Source: Vanguard, using World Bank data. Values in current (2018) UK pounds.

China's share of total world GDP, 1960–2016

1960197019801990200020102016
4.4% 3.1% 1.7% 1.6% 3.6% 9.2% 14.8%

Source: Vanguard, using World Bank data.

Prospects of more sustainable growth have improved

While this economic growth is promising, it's unrealistic to expect it to continue at such a dramatic pace. In fact, China's growth rate has more than halved in recent years as the country's heavy reliance on investment and exports fuelled by massive debt accumulation has become unsustainable. For China to progress onto a more sustainable growth path, Vanguard believes emphasis must be placed on growth quality as opposed to just quantity.

Indeed, policymakers in Beijing have begun to shift their economic priorities.

Recent government decisions and regulations, such as financial tightening and supply-side policies, make it clear that Chinese leaders are committed to moving towards a healthier growth model. And while these developments may have a slight dampening effect on growth in the short term, they have made Vanguard's economists and other observers more optimistic about China's long-term prospects. We have started to see encouraging progress in rebalancing policy priorities from investment to consumption, and from manufacturing to services.

As shown below, over the past decade, consumption has contributed more to GDP growth than investment while the service sector's share of China's economy has risen to around 56% of the economy.3

China's rebalancing act

why china chart

Source: Vanguard, using data from CEIC and NBS.

The most likely outcome: Smooth rebalancing

Vanguard believes the future of China's economy will be shaped by two main domestic forces: macro-level policy cushions and progress on structural reform.

In the short term, the PRC's leaders will need to skilfully use policy tools to engineer a soft landing – that is, a gradual reduction in the GDP growth rate that avoids pulling the country into recession. In the long term, China will be tasked with implementing structural reforms that effectively bolster productivity and GDP growth while staving off the stagnation that often afflicts middle-income countries.

As outlined below, other possibilities include a hard landing (with attendant capital flight and risk of recession) or Japan-style stagnation. However, Vanguard believes prudent policymaking, a supportive macro policy cushion and structural reform progress have lowered these risks. We envision a smooth rebalancing as the more likely outcome over the long run. The Chinese government has an array of monetary, fiscal and regulatory tools available, along with the ability to unleash long-term growth potential by implementing timely, effective structural reforms. This should bode well for China's long-term growth potential and should enable the PRC to remain a vital and productive participant in the global economy.

The economic outlook: Vanguard's view

ScenarioProbability
Smooth rebalancing: China successfully engineers a soft landing with effective structural reforms. 40%-50%
Japan-style stagnation: No effective structural reform, but government able to cushion the economy. 25%-35%
Hard landing: Limited policy cushion and capital flight lead to hard landing, pushing China to implement effective structural reform. 10%-20%
Emerging-market instability: No effective structural reform with limited policy cushion results in economic crisis and growth stuck at low level. 5%-15%

In short, we believe China's importance to the world marketplace will continue to grow, and that the risks of a hard landing are muted by recent economic developments. With this potential for long-term growth, global investors will be well served by understanding their options for including exposure to China's dynamic market in their portfolios.

1 Vanguard, using data from World Bank.
2 United Nations Conference and Trade Development.
3 Vanguard, using data from CEIC and NBS, as at 31 December 2017.

Important risk information:

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.

Other important information:

This article is directed at professional investors and should not be distributed to, or relied upon by, retail investors.

This article is designed only for use by, and is directed only at persons resident in, the UK. It is for educational purposes only.

This article was produced by The Vanguard Group, Inc. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.

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