China’s late-bloomer advantage in the current crisis

By Patrick Tan, Founder and Branch Partner

One man’s poison is another man’s meat, so the saying goes. As far as the current financial crisis is concerned, the toxic debts and assets poisoning the economies of some of the most affluent countries in the world represents a prime cut of meat for China’s growth. The fact that China’s economic rise will be astounding and unprecedented cannot be doubted, thus investors should understand why this crisis will be pivotal to its growth.

Although China is already the third-largest economy in the world, it still has a long way to go before it can pose a real challenge to America – its GDP stands at US$4.3 trillion compared to the US$14.26 trillion economy of the US. But China finds itself faced with a golden opportunity to play catch-up while the rest of the developed world is mired in the current economic mess caused by their own regulatory mismanagement.

It is no secret that, armed with the world’s largest foreign exchange reserves estimated at US$1.95 trillion, China is able to make significant upgrades to its infrastructure without relying on external financing. This, in part, has allowed its domestic banks to de-leverage in recent years and the country to remain relatively unscathed by the current turmoil. That in itself gives it a major advantage while its competitors writhe in over-leveraged agony and debt.

Another significant factor is China’s advantage as a late-bloomer. In the later part of the Twentieth Century, while developed countries spent massive sums upgrading their communication infrastructure – laying cables and investing in other hardware, China – then still adhering rigidly to a Communist economic model – missed out on that revolution. Today however, a resurgent China is able to pump its capital into developing a modern wireless infrastructure without having had to go through the wired phase, effectively leapfrogging an entire generation of technology and saving itself billions of dollars.

This crisis will also allow China to relatively easily remodel its still-developing economic growth engine, driven by different sectors requiring different job market skills. If I placed myself in the Chinese government’s position, I would be gleefully opportunistic with the current turmoil.

China is taking strong steps this year to cement its economic rise in tandem with an inevitable global recovery. According to the IMF, the central government is significantly increasing its spending on critical social programmes in 2009. Healthcare spending will increase 38% on year, education will go up 24% and investments in social safety nets will rise 22%. Consider these increments while almost all its developed competitors are wracking their financial nerves and slashing their national budgets.

The central government is also boosting the consumption rate of its formidable rural market – estimated at more than 700 million – by giving them a subsidy of 13% for the purchase of appliances such as colour TVs, refrigerators, washing machines, cellphones, computers, air conditioners and microwave ovens, etc. Other efforts to stimulate consumption include a programme to increase the number of stores and distribution centres in rural areas while renovating and standardizing rural food markets.

With the transformed infrastructural landscape and increased standards of living, investors can be confident urban and suburban property values will rise and stabilize in the medium-to-long term while equities in the manufacturing, financial and shipping industries – to name a few – will also be primed for a boom.

But even with everything going for it, China’s growth can only rebound significantly and in a sustainable manner when the world’s economy fully recovers. And this is unlikely to happen soon. To be sure though, with a general sentiment of lost confidence in the US and European markets, funds will continue to gush into China, setting the stage for its GDP to skyrocket in the medium-to-long term.

While some like to think of China in its current state as a waking dragon, I prefer to see it as a mere lizard with the potential to evolve into a dinosaur. The contrast between the China of today and the China of the next decade-or-so will be mind-boggling. With 1.2 billion people hungry for growth, a strictly-regulated financial system and a brilliant, stable and efficient central government, the country is primed to be a significant actor in the next bull-run. Investors have every reason prepare for it now.