The Deloitte Research Monthly Outlook and Perspectives
22 July 2021
Battening down the hatches for the long road ahead
It has come of no surprise that China registered Q2 GDP of 7.9% with exports continuing to perform superbly and consumption finally pick up again in recent months. The most important factor behind this is the momentum of the post-covid recovery. The reason that Q2 growth is clearly far above the medium-term growth trend is not just due to exports outperforming, but also the fact that leverage ought to be addressed next year rather than this year. Nevertheless, the Q2 data has prompted us to revise 2021 GDP growth downwards from 8.0% to 8.2%.
Inflation has been a headline grabber this year not just due to the global economic recovery, but also due to the dovish stance taken by the Fed. Rampant speculation seen in various asset classes, from real estate to crypto currencies, has raised questions as to whether major central banks (mainly the Fed) can stay ahead of the curve. As of now, the market expects the Fed not to hike the Fed Fund Rate until early 2023, but such expectations could change, especially in light of headline inflation in the US continuing to surprise on the upside (YoY 5% and 5.4% inflation in May and June respectively). If the housing boom persists, which has been a global phenomenon, will the Fed be compelled to raise interest rates earlier than previously expected? If so, would emerging markets be able to withstand heightened volatility in financial markets? What would be the optimal policy response in China if the Fed leads an exit campaign of monetary easing?
In our previous issue, China to resist forced RMB appreciation, we flagged concerns by Chinese policymakers over "less responsible monetary policy" conducted by major economies, essentially referring to the US and Eurozone. Such concerns really boil down to China's policy dilemma – an early withdrawal of liquidity may undermine the recovery's momentum but a continued accommodative monetary stance may make housing bubbles even bigger. China's housing bubble is different in many ways from previous boom-to-bust cycles. First of all, China's investment boom has not been financed by capital inflows as was the case in South Korea and most ASEAN economies in the mid-1990s. Second, Chinese consumers are largely conservative, with the current consumption boom chiefly fuelled by younger generations. Third, policymakers have been trying to drive credit away from the property market for years. Notwithstanding the unique characteristics of China's property bubble, it is also factually true that many third and fourth tier cities are experiencing population outflows, especially in the northeast provinces. We have held a consistent view that, all thing considered, policymakers prefer to see a stable housing market. Rapid price appreciation, even in small pockets of the country such as Shanghai, Shenzhen, Guangzhou and Nanjing, may increase the likelihood of future price declines if bubbles pop. Price declines will result in shortfalls of local government fiscal revenues.
Unlike most countries, China could adopt unorthodox measures if conventional tools such as interest rates are not feasible. For example, mortgages on second-hand homes in Shanghai are denied outright. In cities where prices have seen significant increases this year, local governments have set a ceiling on prices of new homes. Of course, buyers are trying harder to obtain new homes when they are at a deep discount compared to second-hand homes. Such administrative measures are by no means perfect but avoiding wild price gyrations is viewed as a key policy objective in China. From this perspective, cuts to the reserve requirement ratio (RRR) last week has served a number of purposes.
The Chinese economy is currently cruising on both base effects and favorable external demand driven by the US recovery. However, there is an increasing recognition that growth for next year could be challenging if consumption remains a laggard while export growth decelerates. According to a PBOC survey, consumers have become moderately more upbeat as evidenced by booms seen in major holiday resorts, yet the desire of firms to invest has been dampened by roaring commodity prices and has fallen further in Q2 of 2021. Therefore, a 50bps cut to the RRR is a pre-emptive move. In our previous issue, we also argued that policymakers have become uneasy with the RMB's one-way appreciation. Reducing the RRR will narrow interest rate differentials between China and the US. In addition, if history is of any guide, the RRR could be as low as 5-6%.
Chart: RRR could reach historic lows of 5-6%
In theory, China could even ease monetary policy no matter when the Fed hikes rates. In practice, China is unlikely to do this unless growth comes down substantially. With the RMB almost at a 15 year high against the dollar, Beijing could adjust exchange rate, say by 5-7%, as a lever of easing monetary conditions and boosting firms' competitiveness.
Returning to the discussion on inflation, those who hold the view that inflation in the US is transitory in nature have based their arguments mainly on slack in the labor market, uneven increases of inflation components (those which are closely linked to opening up the economy have seen large price increases) and well-anchored inflation expectation (US 10 year treasury yield). For China, the key economic challenge is not inflation but a profit squeeze caused by those who are unable to pass higher input prices onto final demand. On July 14, Premier Li Keqiang laid out his views on the economy at a weekly State Council meeting, stating that the recovery is on track but surging commodity prices have resulted in difficulties to firms, especially SMEs. This prognosis clearly calls for a dose of relief to firms which are most heavily impacted by covid and the commodity boom.
Chart: increases of inflation components for the US in Jun 2021
Transformation of China's asset management industry accelerating
In order to mitigate against the pandemic's negative impact on the economy and finance, the transitional period of the New Asset-Management Regulations has been extended from 2020 to the end of 2021. Along with the ongoing economic recovery, the deepening of capital market reform and further opening-up of the financial sector, the transformation of China's asset management (AM) industry is accelerating. In May, ICBC Wealth Management Co., Ltd. was approved to set up a joint venture subsidiary with Goldman Sachs Asset Management. In June, CITIC Securities, the first securities firm with assets of more than RMB1 trillion, announced the establishment of its AM subsidiary. At present, China's big state-owned banks have embarked on a new transformation by establishing Sino-foreign joint venture AM subsidiaries. At the same time, about 20 securities firms have also set up AM subsidiaries and China's AM institutions are becoming more diversified, whose business models are becoming constantly standardized. We can expect to see further broad developments in the Chinese AM sector in the future.
The key lies in supporting the real economy and developing direct financing
Guo Shuqing, chairman of China Banking and Insurance Regulatory Commission (CBIRC), said at the 13th Lujiazui Forum in June that "the most prominent task now is to further boost the share of direct financing, especially the bond market which still has great potential", mainly emphasizing financial support for the real economy. In order to develop an innovative economy, it is necessary to solve the problem of structural imbalances in the sector and improve the allocation efficiency of capital market resources. Therefore, to adjust the private financing structure, increase the proportion of direct financing and develop its capital markets, China needs a new collection of professional institutional investors and a well-regulated AM industry.
Absorbing foreign practices to enhance the competitiveness of the AM industry
In June, Investment & Pensions Europe (IPE), a leading European publication, issued its global list of 2021 Top 500 Asset Managers, of which the China section is compiled by its London-based co-operation agency ATC (Allocate to China). The results show that while the top spots are still dominated by foreign institutions, the most competitive Chinese AM institution have broken into the top 40. This reflects the growing demand from overseas institutional investors to tap into China's AM market and their eagerness to learn about the excellent asset managers in the country through the list. China's top 30 AM companies include the largest AM institutions in the country, with an asset volume of EUR5.41 trillion (RMB42.03 trillion), accounting for 35% of the industry's total size. Included among the top 30 companies in China are 14 fund companies, 9 insurance AM companies, 6 wealth management subsidiaries of banks and 1 securities company, all of which are potential high-quality partners for overseas top AM institutions.
Chinese bank AM subsidiaries are often referred to as "wealth management companies", but they are more similar to asset managers in terms of business operation and type. The advantages of Chinese banks lies in the channels and customer relations, while their professional investment and research capacity may be lacking. Leading international asset managers do well in investment research, professional operations and risk management, and they highly value the access and resources Chinese banks command. Therefore, the two sides can fully draw on each other's strengths in cooperation.
Chart: State-owned banks set up joint-venture AM subsidiaries with foreign institutions (as of May, 2021)
Trillion-size market and booming opportunities
In 2019, China's per capita GDP was USD10,276, exceeding USD10,000 for the first time in history. In 2020, this number continued to increase during the pandemic reaching USD10,504, and the International Monetary Fund (IMF) forecasts that China's GDP per capita will reach USD25,307 by 2025. According to the 14th Five-Year Plan and the Long-Range Objectives through the Year 2035, China's per capita GDP is targeted to reach the level of moderately developed countries by 2035, and the size of the middle class will significantly expand. According to the 2021 Global Wealth Report released by Credit Suisse in June, China's national wealth currently stands at USD74.9 trillion, second only to the United States. China has been the biggest contributor to the economic growth of emerging markets and this dominant position looks set to continue. In the next five years, China is expected to account for more than a quarter of the increase in global household wealth. As the number of wealthy people continues to grow in China, the wealth management market will gradually release its huge development potential, providing abundant capital and opportunities for the improvement of the AM industry.
The New Asset-Management Regulations stipulate that rigid payment requirements are removed, the principle for wealth management products are no longer guaranteed, and the expected return of wealth management products is reduced. At the same time, the tightening of real estate regulations and policies continues. As a result, the attractiveness of investments in the equity market is on the rise. For China's AM industry, there is still a long way to go in its transformation to becoming an internationally competitive market. With the constant promotion of financial liberalization, we can expect to see greater competition between Sino-foreign joint venture financial companies, securities companies, funds, trust, insurance companies and other players. This will further enrich the types of participants and products in the domestic wealth management market, thereby supporting the development of the real economy and, at the same time, meeting people's diversified investment demands.
The record-breaking numbers behind the 618 Shopping Festival
This year's 618 network-wide sales festival broke another record. According to StarChart data, June 1 to June 18, the total GMV transaction volume of the entire network reached RMB578.48 billion, an increase of 26.5% on last year. In addition to the rapid growth of online platform, compared with previous years, this year’s 618, in the later stage of the pandemic, showed new characteristics.
First of all, similar to the Double Eleven Shopping Festival, this year's 618 sales period continues to expand. The e-commerce platform stated that in order to boost sales and ease the pressure on inventory shipments, the 618 promotion will start from June 1. Secondly, this year's 618 marketing and promotions have been relatively quiet. As the country has strengthened its supervision and crackdown on anti-competitive behavior such as 'choosing only one out of two platforms' and 'big data cracking', platforms are no longer simply emphasizing their sales performance. Instead, online platforms have shifted their focus to developing new products and unique categories, as well as developing new models and new formats that enhance consumers' shopping experience. Furthermore, live-streaming has become the norm. In this year's 618, the five major live e-commerce platforms of Tmall, JD, Pinduoduo, Douyin, and Kuaishou each registered high sales performances. From the product category perspective, the focus on selling goods on various live-streaming platforms has centred around differentiation. For example, beauty, sportswear and 3C home appliances saw high sales performance on Tmall, while JD received larger traffic and sales in luxury goods, smart pet products and beauty products. More so than in other categories, higher sales were achieved during the shopping festival in 3C home appliances and agricultural products on Pinduoduo, 3C appliances, clothing, food and beverages on Douyin, and beauty products, clothing and gold and jewellery on Kuaishou.
However, on the whole the 618 online Shopping Festival in 2021 was generally flat. The reasons for this are mainly as follows:
- The extension of the sales promotion period in the Shopping Festival reduced consumers' shopping needs. With the gradual extension of the promotion cycle, coupled with such marketing methods as live-steaming and 'tens of billions in subsidies', consumers have lost the impulse to consume, and consumers who are accustomed to the long-term promotion model have gradually turned to more rational consumption. This will also lead to a further decline in the shopping festival’s appeal to consumers in the future.
- The attractiveness of sales promotions to young people during this year’s festival has declined. Today's consumers have an increasing demand for personalization, fashion, and socialization. Not only that, their consumption methods also include the need for both convenience and instant availability. From the category perspectives, mobile phones, sportswear, and beauty and skin care products are the categories that achieved a better sales performance this time around. We see that the top sales were all held by brands that have focused on the personalization, fashion and social needs of Generation Z for several years.
- High customer acquisition costs have weakened brands’ enthusiasm for public domain platforms. In 2019, mobile network users reached 1.13 billion and remained basically flat-lined. As a result, the e-commerce industry is gradually moving towards a period of stagnation. Corresponding to the increase in traffic is the slowdown in the growth rate of domestic online retail sales. According to data from the National Bureau of Statistics, the growth rate of domestic online retail sales in 2017 was 32.2%, slowing to 10.9% in 2020. Against this backdrop, we have increasingly seen that brands are building their own private domain traffic pools driven by digitalization, as well as an online and offline integrated omni-channel model to reach customers.
Education industry under enhanced regulatory enforcement
China's education industry experienced an unprecedented wave of inspections and governance enforcement in 2021. The Ministry of Education (MoE) released a series of new policies to limit in-person training programs, ban false advertising, prohibit excessively age-and-grade inappropriate education, and accelerate compulsory education system reform. In light of promoting educational equality, policymakers have enforced new regulations in order to uproot unlawful activities and perfect industry management, supervision and governance. At the same time, the MoE is also looking to further eliminate the need for out-of-school education and training by deepening compulsory education system reform.
- Comprehensive inspection and rectification of false advertising, instructor credentials and fee collection
Starting in 2021, the Chinese government has intensified inspections on advertising, instructor qualifications and the collection of tuition fees within the education industry. Many regions in China have introduced new policies aimed at better filtering advertisement content and preventing false advertising. To remove unqualified instructors from the sector, the MoE has screened the industry for teachers lacking official certification. The MoE then ordered a total ban on education materials produced by these uncertified instructors. More regions around the country have also enforced financial inspections on education organizations. Meanwhile, investigations into tuition prepayment are still ongoing.
- Total ban on excessively age-and-grade inappropriate education programs at the kindergarten level
In April, the MoE published the Guiding Opinions on Vigorously Promoting the Scientific Connection between Kindergartens and Elementary Schools, which emphasized the need for stricter regulations towards excessively age-and-grade inappropriate education at the kindergarten level. The newly published policy also introduced new measures to lessen enrolment pressure. Once this policy is enacted, such education at the kindergarten level will be prohibited.
- Compulsory education system reform aimed at providing better in-school services for all students
Based on the Opinions on Further Reducing the Workload for Students in Compulsory Education and Out-of-school Training, the MoE declared the establishment of the Office of National Education Inspection in June, followed by a series of regional policies to reduce out-of-school education time and activities. The education programs during statutory holidays and vacations will likely be subjected to stricter restrictions. The MoE also published the Notice on Supporting the Exploration and Development of Summer Guardian Services on July 8, encouraging qualified schools to host summer day-care programs and urging teachers as well as students to participate in such programs voluntarily.
Opportunities and challenges ahead: vocational education and character-building education have more room for development
In a time of enhanced supervision and regulation, the education industry will develop more properly, and more resources will be concentrated among the top education companies. As the government moves towards strengthening in-school education, focusing on comprehensive learning, and consummating vocational education, the prospect of further development is being welcomed by industry players in vocational education, character-building education and the digitalization of the education industry.
More room for vocational education development
In the first half of 2021, the vocational education sector received three times more total financing than the K-12 education sector. The online and in-person hybrid education model creates new paths for the development of vocational education, which in turn will help to raise the market penetration rate of the vocational education sector. As more government policies support private vocational education, the sector will see more room for development.
Character-building education welcomes more financing events
The government has repeatedly reinforced the importance of in-school and after-school scientific education and has mentioned the possibility of bringing physical and artistic education into the high school entrance examination system. In the character-building education sector, artistic and physical education, programming and coding education, and thinking cultivation sectors are more popular with venture capital. In particular, as programming and coding education becomes more scientific, its market penetration rate will increase, creating the prospect of hundreds of billions of future funding.
The digitalization of the education industry meets more opportunities
Since 2021, the digitalization of the education industry has maintained its rapid pace of development, as many cloud teaching platforms are becoming more and more popular among the public. In the near future, we can therefore expect to see an increased range of financing opportunities for the digitalization of the education industry.
 The wealth contains financial assets, non-financial assets and debt.