China's Investment Environment: Trends and Outlook

The Dbriefs China Issues series presents:

China’s Investment
Environment: Trends and
Outlook

Chris Cooper, Partner, Deloitte & Touche LLP
Ken Dewoskin, Senior Advisor, Deloitte Touche Tohmatsu CPA Ltd.
David Hoffman, Vice President and Managing Director, The Conference Board’s
China Center for Economics and Business

December 13, 2012

Agenda

China at an inflection point

New leadership

The outlook

Question and answer

Copyright © 2012 Deloitte Development LLC. All rights reserved.

The lessons of 2012
After a full generation of reform, and three
orderly leadership transitions . . .

Levels and drivers of
growth transforming A new team of top Party leaders
Concerns about sustainability—
Imbalances at ―red at home and abroad
alert‖ level
Recalibration of China’s prospects
New external
environment & attitudes

Comprehensive MNC
investor strategic refresh

1 Copyright © 2012 Deloitte Development LLC. All rights reserved.

Polling question #1

Given your recent experience and media reports, has
China’s importance in maintaining your global market
share:

• Become more important?
• Stayed the same?
• Become less important?
• Don’t know/not applicable


Transformation of growth drivers
Big growth vs. quality growth
What generates the activity?
Who gets to spend the money?
 Major reform growth driver
Net Exports
▼  Trade surpluses in steady decline
 Global demand? Competitiveness?

 Rising growth driver since 2003
Investment
▼  Largely State-driven
 Rapidly declining ROI

 Designated growth driver from 2008
Household
Consumption  Growing but too slowly
 Core structural problem

Sources: The Conference Board, Deloitte Research


Household consumption
Will it rise to the challenge?
Percentage points (contribution to growth) Percent of GDP
30 50
Household Consumption

25 45 Government Consumption

GFCF
20 40
Net Exports
15 35
Real GDP Growth

10 30 Household Consumption
Share of GDP (RHS)

5 25

0 20
1996
1991
1992
1993
1994
1995

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Decomposition of China’s GDP
(expenditure side)

Sources: PRC National Bureau of Statistics, CEIC Data Bases, The Conference Board

China’s middle class on the edge . . .

 Move spending power from the state to households
ESSENTIALS
 Radically improve wealth distribution

1. Demographic Shift – Moving toward a 2:1 worker-retiree ratio
2. Social Welfare Deficit – levels of precautionary savings
3. Services Sector “Marketization” – availability and choice
4. Consumer Wealth – options and security
5. Consumer Credit – Will it grow?
6. Inflation– structural drivers, state spending, and money supply


Polling question #2

What are your expectations of China’s middle class and
the future of consumer spending?
• Continued strong growth of size and spending power
• Plateauing
• At risk of contracting


New leaders facing new challenges

1. Scrutiny and accountability from social media and global
journalism
2. More international experience in elite population
3. More international experience among leaders
4. First heavily hereditary regime
5. Much more complex economy, data weaknesses, and control
weaknesses


Three big decision areas
Components Obstacles

Moderate Japan, disputed islands
regional China trade practices
diplomatic Vested interests
activity In and outbound investment
• Large SOEs/LNEs
• Regulators
Capital allocation
• Elite families
Reform & Holder of spending power
expand credit
Investment security Immature institutions
systems
Risk-based returns State ownership
Politicized private sector
Market-based transfer pricing No institutional independence
Implement Curtail monopolistic practices
SOE reform
Bankruptcy and debt constraints


Time frames and outcomes

Wave 1: 0-18 months Wave 2: 12-48 months

Moderate No Scenario 3:
No Scenario 1:
regional Muddle
diplomatic New Isolation
Kingdom
activity

Yes
Leadership Choice Point
Implement
Scenario results
SOE reform
Yes

Reform & No Scenario 2: Yes Scenario 4:
expand credit Financial Some Pain,
systems Cliff Some Gain


Polling question #3

Do you believe the risks of policy failure, and the
potential impacts on your business, in China are:
• High
• Medium
• Low


Five “breaking” stories – December 2012
1. Corruption: China ranked 80th this year on this year’s Transparency
International index, with a score of 39 in terms of perceived corruption.

2. Shadow banking: New wealth management products (WMP) may
represent 13% of all lending, about US$1.9 trillion. Shanghai Huaxia
related WMP default sent shockwaves through the banking system.

3. Capital market performance: ―A‖ share markets worst in world. Wave of
layoffs at securities companies as revenues from underwriting, along
with the number of companies planning IPOs, both hit record lows.

4. China’s property market: A transaction media between the government,
enterprises and citizens. Additions to public and private debt since the
housing boom began in 2006 amount to ~200% of China’s 2011 GDP.

5. Signs of recovery: Proliferation of news articles, global stock market
reactions, and official reports from China celebrating end of slowdown
Source: Transparency International Corruption Perceptions Index 2012, Fitch Ratings


Bulls and Bears
China in the years ahead: complex and unprecedented

Outlook on China’s
Worst now medium-term economy Unprecedented
behind us challenges ahead

Investment International
Top government
Bankers press
leaders
Government data Consultants
collectors

Who’s saying what (and why?)


What many MNC China CEOs report today
Eleven and a half snapshots
• Oil and Gas: Lagging regulations (shale), highly protected sector
• Alternative energy: Vast overcapacity, pricing collapse, LNE stress
• Manufacturing: Soaring factor prices, slow growth domestic demand
• Retail: Steady 8%-10% annual growth, rising payroll, tight margins
• Engineering equipment: Collapse of demand, desperate domestic players
• Banking: Labyrinths of regulations, highly protected markets
• Equity investment: Entry & exit challenges, insider game, rule changes
• Infrastructure (rail, etc): Steady 10%-15% growth, margin pressure
• Catering services: Steady 15%-20% growth, soaring payroll costs:
• Luxury goods: Flat to -10% sales
• Automotive: -5% to +5% growth, move to smaller cars, tough regulations,
Japanese Auto: Freefall
Sources: Deloitte analysis,, NBS

Potential responses by MNCs
Three themes 1. Intense cost management
2. Right products and technologies
3. Super brands

And five steps
 Prepare for potential increased attention from local tax and compliance
authorities, overcapacity, slowing demand, SOE/LNE competition
 Set (or re-set) realistic expectations at corporate level for China market
growth and profitability
 Accelerate 21st century new product development (NPD) thinking
regionally as well as nationally
 Structure investment in organization and capacity for agility and watch
long-term commitments, accounts receivables and cash flows
 Understand and align with local interests/champions to the extent
possible & prudent; explore new kinds of on-shore / offshore cooperation


Polling question #4

Over the next five years, which of the following do you think
poses the most significant challenge for U.S. companies in
China?

• Increasing competition
• Intellectual property issues
• Rising operating costs
• RMB volatility
• Slower growth
• Human capital/talent shortage


Join us January 10th at 11 AM ET
as our China Issues series
presents:

Beyond the Commodity
Downturn: China's and North
Asia's Impact on the Global
Mining Industry

CPE certificates are now available
for immediate download.

Click the Request CPE link in the
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Contact info

Chris Cooper
chriscooper@deloitte.com
+1 408 704 2526

Ken Dewoskin
kdewoskin@deloitte.com.cn
+86 10 8512 5601

David Hoffman
david.hoffman@conference-board.org
+86 10 8532 4688


This presentation contains general information only and Deloitte is not, by means of this
presentation, rendering accounting, business, financial, investment, legal, tax, or other
professional advice or services. This presentation is not a substitute for such professional advice
or services, nor should it be used as a basis for any decision or action that may affect your
business. Before making any decision or taking any action that may affect your business, you
should consult a qualified professional advisor. Deloitte shall not be responsible for any loss
sustained by any person who relies on this presentation.


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China's Investment Environment: Trends and Outlook

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