China 2011: What the Demographics Tell Investing Businesses

January 11, 2011 Posted by China Briefing Reading Time: 5 minutes

Op-Ed Commentary: Chris Devonshire-Ellis

Jan. 11 – It looks like 2011 is set to be a year of challenges and the forerunner to change in China. With fallout from the Global Financial Crisis still impacting upon consumer markets, China’s exporters are still feeling the pinch. Indeed, the entire export processing industry will start to vanish in China to other shores as the increasing expense of Chinese labor continues to kick in. The resultant shift to accommodate this in a structural move to reposition the economy to a domestic consumer market has not yet really begun to be implemented – much of the consumerism over the past 2 years we have seen from China has been based on long term unsustainable policies – almost nonexistent interest rates, widely available cheap credit and government sponsored discount schemes to encourage people to spend.

While this may be good short term news for auto manufacturers, the housing and stock markets, it also potentially signals an overheated economy buoyed up by government spending and the potential for China to be amassing massive amounts of bad debt in its banking system. Some banks and financial analysts are concerned, and although they remain a minority in terms of talking up the seriousness of the issue, my own meetings and debates with a number of high profile academics and analysts this year reveal a divided school of thought over the possibility of China having rather larger financial and debt problems than is admitted. At best, the jury is out on this one – at worst a serious problem is developing. Whether that manifests itself in 2011 or later, or can be absorbed, is a more prudent debate. My advice would be to keep plenty of cash reserves on hand during 2011. Credit is tightening, and if in need, readily available funding might be hard to come by if the China consumer market becomes sour.

2011 also provides a year of political strangeness – the next five year plan will be unveiled in March by Hu Jintao, yet at the same time, political jostling for power continues as a new leader is to be elected in 2012. Xi Jinping, who is expected to take over from Hu Jintao, will have to work with a completely new team of officials yet to a plan already defined by his predecessors. Such are the disciplines of a one party state that a new leadership must work to a plan dictated by the old. While this transition is on-going during 2011, it is unlikely that any major developments – short of a financial crisis of its own – will occur in China. However, due to the process, China tends to act in a more aggressive manner in foreign relations, effectively warning other nations not to tread on its toes while the political process of assembling the next generation of leaders is underway.

As we have seen during the past 12 months, China has become embroiled in occasionally nasty disputes with several of its neighbors. More of the same can be expected. A further stress line lies with the situation in North Korea. What is really going on there – aside from an internal succession that may yet have to prove itself strong enough to survive North Korea’s own internal politics is a matter of some debate. China will be hoping that North Korea will remain quiet during 2011 to allow time for the new Chinese leadership to grapple with the problem. However, if North Korea wishes to force China to act on its behalf it may escalate trouble by seeking to antagonize just as it perceives leadership regime change in China a vulnerable nerve to provoke. North Korean behavior in 2011 may yet define the year.

These concerns aside, there is plenty to look forward to in China 2011. In my view, the year should be treated as a platform for development. While it will take some time to determine the real extent of value within Chinese consumerism, there is no doubt that the demographics are changing. China is set to double its minimum wage within the next five years, and is increasingly moving its technical know-how to more value added products and services. Indeed, conversely, the start of the next decade may well usher in a golden period of Chinese domestic growth. The end of the decade in 2020 will see the first tier Chinese cities attain the same type of wealth in terms of purchasing power as those in Western Europe and the United States. Meanwhile, China’s inland cities will provide even larger growth in terms of emerging consumer markets – inland market penetration in China is where the smart money will be, and we’ve spent some time in this report in demonstrating where these are expected to be. Getting strategy right for production and sales into the Chinese hinterland then is the real development target for 2011.

Beyond this, some businesses will also now be able to look at other markets, and use China as a base for developing and expanding into these. Opportunities in Asia fall essentially into two categories; the continuation of export driven manufacturing in cheaper labor pools, and the development of consumer markets elsewhere in Asia. One country stands out in being able to offer both, and that is India. However, smaller markets, driven by booming capital cities are also becoming attractive, and Malaysia, Indonesia and Thailand all offer alternatives with increasingly affluent urban populations. Meanwhile, as American and European consumers will not accept price increases at present for cheaper products, low labor cost markets such as Bangladesh (garments) and Vietnam (light manufacturing) provide good ex-China alternatives. Further afield, the likes of Cambodia and the Philippines provide options.

Whatever transpires, there is no doubt that 2011 will be a year of some bumps and bruises. However, with careful planning, prudence, and attention to financial detail, it should provide a development platform to allow companies to implement strategic plans for building infrastructure to get further into the China market.

This article was taken from the recently published China Briefing 2011 Investment Demographics special 42-page issue which may be downloaded on a complimentary basis from the Asia Briefing Bookstore. The special issue also covers:

China’s 2011-2015 Five Year Plan
China’s Potential Credit Bubble
The Extinction of China’s Export Processing Trade
The Demographics – Where 2011 Investment is Heading
China’s Fastest Growing Cities
China’s Fastest Growing Provinces
China’s Wealthiest Cities
China’s Second Tier Cities – The Third and Fourth Are Catching Up
China Auto Repair and Servicing – The Next Big Thing?
Time to Convert Your RO to a WFOE
Tax Incentives Being Phased Out in 2011
Executive Summary for 2011
Five Tips for Improving Corporate Effectiveness

Chris Devonshire-Ellis is the principal and founding partner of Dezan Shira & Associates. The practice has been operational in China since 1992 and provides legal administration, establishment and tax planning services, in addition to ongoing compliance and maintenance issues with customs, tax and labor law to investors in the China market. The firm has 10 China offices. Please visit firm’s web site, e-mail the firm for advice at legal@dezshira.com, or download the firm’s brochure here.