The Deloitte Research Monthly Outlook and Perspectives
6 April 2022
The key to stabilizing expectations
Should policymakers adjust their economic growth target of "around 5.5%" which was set during the Two Sessions? If not, what policy measures could be undertaken so that any adverse effects of the Ukraine-Russia crisis can be mitigated? Broadly speaking, both financial markets and the real economy have witnessed shock waves which can generally be characterized as surging energy prices, investors' risk aversion and higher geopolitical risks.
Before we answer this question, it is necessary to first gauge the social and economic cost of the crisis. First of all, the mounting loss of life and growing number of refugees (more than three million and counting) has created a humanitarian crisis in and around Ukraine. The scale of the calamity has actually hardened the resolve of the West, which in turn could prolong the stalemate in Ukraine. Second, the conflict has increased stagflation risks in the global economy, with a recovering European economy now flirting with recession. And third, geopolitical risks have resulted in capital outflows from the region with Hong Kong bearing more of the brunt. Such heightened stagflation risks and geopolitical tensions are affecting China in a profound way as evidenced by the sharp sell-off of A-shares and on the Hang Seng Index which is dominated by Chinese companies.
It is true that China's direct trade linkage with Russia is moderate (nearly US$150 billion in 2021, compared to US$828 billion and US$756 billion with the EU and US respectively), but Russia and Ukraine are key exporters of energy products, minerals, and agricultural produce. On this column, we have repeatedly written about the negative impact of rising crude oil prices for Asian economies (many of them are export-oriented). It is difficult to pinpoint the exact threshold for crude oil prices from a standpoint of higher inflation in Asia, but above US$100 per barrel on a sustained period will cause inflation overshooting and fiscal scrambling in several regional economies (e.g., most ASEAN economies and India). Of course, if higher prices are caused by supply disruptions as is currently the case, instead of stronger demand, policy choices will be further reduced. Should the conflict come to a close within the next couple of months, and assuming elevated crude oil prices gradually come back down to last year's level, most regional economies could still see their GDP growth rate shaved by 0.5% and inflation a tad higher from our original forecasts for 2022 (please see our forecasts from the last issue of Voice of Asia).
Figure: Recent rise of steep material prices have been driven mainly by supply-side disruption
China is more resilient than most regional economies, mainly because it does not have to follow the Fed on interest rate movements, runs a moderate current account surplus, boasts a sound fiscal profile, and more importantly, because Chinese consumers have relatively low leverage. That said, the underperformance of China's A shares and the Hang Seng Index, which increasingly tracks the mainland economy, especially after Feb 24 2022, suggests that the profit-squeeze which was seen during the V-shaped recovery in mid-2020 has worsened.
In addition to such external shocks, the geopolitical risk dimension has cast a shadow over Chinese companies with overseas exposure as the West broadens its sanctions against Russia. This is because it is increasingly difficult to define which companies are falling foul of secondary sanctions, especially when mutual trust between China and the US is lacking. The recent sharp sell-off of Chinese Internet companies on the Hong Kong Stock Exchange and those Chinese concept shares which are traded on the US stock market (NYSE & NASDAQ) have indicated that investors were deeply concerned about the risks of de-coupling between China and the US in the financial market sphere. If such de-coupling is exacerbated by geopolitical risks (e.g. the crisis in Ukraine), a downward spiral in US-China relations could make the risk of certain events unquantifiable. That China has recently been willing to make concessions on allowing US regulators to inspect the books of listed Chinese companies does at least suggest that cooperation in certain areas isn't entirely beyond reach. An economic deceleration and stock market volatilities in China prompted a special meeting of the State Council's Financial Stability and Development Committee convened by Vice Premier Liu He on March 16 2022, underscoring the strong desire of policymakers to stabilize expectations and the stock market. According to Liu, regulations concerning platform companies will entail both red and green lights, and more importantly, these regulations will be "transparent and predictable". Liu has also pledged more support for Chinese companies which are listed abroad, in addition to "forceful measures" to support the property sector. On March 21, the State Council also held another meeting on "anchoring market expectations".
So how should policymakers respond when the economy is facing the additional risk of stagflation, geopolitical flashpoints and the possibility of extended lockdowns in other cities? In Premier Li's Government Work Report, fee and tax cuts and greater spending on infrastructure projects were presented as key components of the government's moderate fiscal stimulus for arresting economic deceleration. The question is whether additional measures to boost demand are required. This might sound like a cliché, but China does have policy leeway and consumer resilience remains intact. Geopolitical risk is likely to weaken the Euro and risk aversion will favor the Yen. In the absence of Chinese tourists abroad, on balance, the RMB is expected to stay stable (we only forecast a mild depreciation against the dollar this year). Despite the fact that the PBOC has not cut policy rates after the last FOMC meeting (March 15-16, 2022) amid a bearish equity market and sluggish property sector, we are of the view that there is still room for the PBOC to make monetary policy more accommodative by cutting certain interest rate instruments and guiding the RMB exchange rate lower, but such maneuvering will be less than before. This implies that the fiscal level must take on a greater role than the Ukraine-Russia crisis ex ante.
In Premier Li's work report which was delivered on March 5, the RMB2.5 trillion that has been earmarked for cutting taxes and fees could be skewed more towards SMEs because they are currently feeling the brunt of various lockdowns in many cities including Shanghai. Last year, a number of cities launched consumption coupons to support restaurants, hotels and theme parks, and similar schemes could be done nationally. If the dynamic zero-covid policy continues, it will be even more imperative to provide relief to SMEs and sectors which are more vulnerable to social distancing. Fiscal relief could also come from large SOEs and even the central bank. In fact, for the first time, the Ministry of Finance will get a one-off payment of RMB1.6 trillion (RMB1 trillion from the PBOC with the rest from large SOEs). This is in line with the World Bank's recommendations of raising dividend payouts from SOEs as a key initiative to boost the consumption to GDP ratio. If we take the cue from Vice Premier Liu He, it will be certain that banks will give up some of their profits through narrower interest rate margins as a direct support to the housing market. In order for all of these reflationary measures to take hold, local governments need to calibrate their covid-control measures in such a way that avoids these one-size-fits-all lockdowns.
Figure: Chinese consumers' resilience remains intact
Shanghai and Shenzhen, two economic powerhouses, have undertaken city-wide rolling covid tests, resulting in lockdowns for more than a week in mid-March. It is difficult to estimate the economic cost of such rolling tests in the country, but it is safe to assume that Q1 2022 GDP growth will be lower than Q4 2021. It might be too early to adjust the "around 5.5%" growth target, but it would be sensible to unveil more reflationary measures than previously planned. Unlike in early 2020, a resumption of business activity is important, but it is more important to target final demand. In practice, priority should go to fiscal relief targeted at SMEs rather than funding large infrastructure projects. If policymakers are indeed set on reaching "around 5.5%" growth this year, aside from a faster rollout of fiscal expansion, more "green lights" will be needed to stabilize the expectations of investors and businesses.
HR challenges rise to the fore
In 2021, foreign direct investment (FDI) into China topped RMB1 trillion for the first time, growing by 14.9% y-o-y to reach RMB1.15 trillion. Many multinational corporations (MNCs) in China will be matching this increased investment with an expansion of their overall headcount across the country. According to a HSBC survey of MNCs operating in China conducted in September 2021, 57% will increase the number of employees in China by 5% or more of their total global headcount in the coming year. Yet, foreign businesses are finding it increasingly difficult to fill these positions in addition to retaining their current employees, both foreign and local. Evolving demographic and economic conditions in China have also combined to exacerbate HR pressures on companies.
Steadily rising labor costs have been a persistent concern for MNCs over the past several years and a significant source of increasing cost. This has generally been attributed to inflationary pressures in the economy, and Commerce Minister Wang Wentao recently recognized the pressures businesses in China have been under due to higher labor costs and commodity prices. Alongside inflation, a steady rise in salary expectations among highly skilled workers and graduates has pushed up human capital costs for MNCs. For US businesses across all sectors in China, rising labor costs top their list of HR challenges, while 80% of firms expect average labor costs per person to rise in 2022 compared with 2021, according to AmCham China.
Figure: Average annual employee salary in China
But even as MNCs plan on increasing manpower, they are being forced to contend with higher turnover rates among local staff. Businesses report that much of this flow of talent is going to large domestic competitors who are often industry leaders in China and are hence able to offer more attractive salaries and employee packages to prospective talent. Identifying and recruiting suitable employees is an issue equally shared by all companies in China, and was identified by the National Bureau of Statistics as the biggest challenge facing 44% of surveyed industrial firms. But while the challenge of hiring the right talent may not be unique to MNCs, it appears that factors such as a higher degree of patriotism among young professionals and geopolitical tensions influencing perceptions of foreign firms could be diminishing the hiring power of multinationals.
The effective closure of China's borders has also dramatically altered the prospects of multinationals hiring and retaining their foreign employees. Faced with the logistical challenges of obtaining a work visa, a shortage of direct flights, and stringent quarantine requirements for entering the country, the number of new foreign workers coming into China has slowed to a trickle, while many long-term foreign residents have left. In December 2021, the government extended individual income tax benefits for expatriate workers for another two years, much to the relief of foreign employees and their HR managers who would otherwise have had to consider absorbing the additional costs. This has certainly been well-received by the foreign business community, but it does not address the more pressing challenges of a lack of flights and long quarantines. A labor market survey of German companies in China reveals the extent of the damage: while foreign staff accounted for 7.1% of their workforce in 2016, this has since dropped significantly to 5.4% in 2021. This proportion is expected to shrink even further in 2022, assuming no substantial opening of China's borders.
Implications for businesses and HR managers
Foreign companies will need to adjust their hiring, retention and development strategies in accordance with China's long-term demographic and economic trends. Already some of the most pressing challenges MNCs face, rising labor costs and competition for local talent will be further exacerbated by China's shrinking workforce, with census data showing that China's working population decreased by 6.8% between 2010 and 2020. If companies are to maintain their competitive edge, they will have to raise their offerings in order to continue attracting and retaining skilled employees, especially among younger workers. Where possible, foreign firms should also invest in automation technologies to raise productivity, even if this in turn will necessitate competing for more highly-skilled workers.
Figure: National resident working population percentage per household
The impact of curtailed mobility is being felt right across company workforces and beyond just the inconveniences faced by foreign residents in China. Closed borders inhibit Chinese employees from travelling abroad or temporarily relocating to other offices, thereby limiting their opportunities to learn more about global practices and engage with colleagues around the world. As employees from other countries are not able to visit their Chinese colleagues, this consequently widens the gulf between China and other offices while further limiting the ability of headquarters to identify new innovations or practices from their China firm and implement them globally. Domestically, China's labor market will also be deprived of the kind of international experience that hiring managers in MNCs value so highly, making the task of recruiting the right talent all the more difficult. Since the latest widespread outbreak in China, officials such as Vice Premier Sun Chunlan have stressed that the government will not waver from its current dynamic-zero policy. With few prospects of China opening its borders significantly this year, MNCs must explore more virtual means of better integrating their Chinese workforce with other global offices while encouraging current foreign executives to stay put.
Can NFTs continue their run?
From U.S artist Mike Winkelmann, aka. Beeple, selling his digital artwork for nearly USD 70 million, to Jay Chou selling out his limited edition NFT in an hour for RMB 62 million, people and companies from all walks of life – from sports stars and pop stars to luxury brands and media & entertainment companies - are rushing to enter the NFT market, thus making NFTs among the hottest commodities in recent years.
An NFT (Non-Fungible Token) is a digital asset stored on a blockchain. It is a unique, authentic, and un-interchangeable digital proof of stake of decentralized encryption. In short, an NFT is a "virtual digital asset" which can be sold and traded. An NFT may be associated with an artwork, video clips, music, tickets and much more. Although NFTs have been in the market for a while, the scale of such encrypted digital assets has been continuously increasing and reached its highest level in 2021 when total NFT transactions were recorded at USD 14 billion in 2021, 1.3 times higher than the total transactions in the global art market in 2019 (USD10.6 billion) prior to the covid pandemic.
There are four main reasons driving the rapid growth of NFT art. First, demand for digital assets amongst young consumers is much higher than the initial market expectation. One reason for this is the uniqueness of NFT products strikes a chord with the younger generation. Second, the pandemic placed severe constraints on traditional models of doing business, hence companies are actively seeking out innovative business models to gain a competitive edge. Third, compared to the traditional auctions conducted under the auspices of leading brokers, transactions of digital artwork are more transparent. Lastly, the easing of macro monetary policy has meant that investors are more willing to take risks, which also helps drive the market higher.
Currently, major NFT applications cover a variety of digital content including images, audios, videos and gaming media. A wide range of NFT ecosystems and transaction platforms have also been developed. Art NFT collection has been a hotspot amongst application areas and the transaction prices of Art-NFTs on major transaction platforms has been rising. Another fast developing field for NFTs is the gaming world. `Trading card’ is the core NFT application in the area of copyright with regards to gaming. Gamers are able to create gaming NFTs that are freely tradable. However, NFT development is not the same in the domestic and overseas markets. In China, the NFT market is primarily led by top players such as Alibaba and Tencent, who focus primarily on digital copyright. In contrast, the overseas NFT market is more diversified, and users are also involved in creating NFT content, which improves the efficiency of NFT monetization.
With the acceleration of digitalization, we expect that there will be more types of digital assets emerging in the market, and NFTs will become more attractive in the digital economy.
- NFTs help create new business models and channels for brands, creators and consumers. As a new way of marketing, NFTs offer many opportunities. Luxury brands, for instance, can offer NFT virtual luxury products in mobile games. This new would increase their reach and enhance brand exposure in a short period of time, as it would attract the attention of young NFT consumers while strengthening brand loyalty amongst existing consumers. Also, because of the non-fungible nature of NFTs, counterfeiting is very difficult.
- The sports industry is a big growth engine for NFTs. As most of the current sports NFTs are exclusive tokens related to sports teams, the growth of the sports NFT market depends on close collaboration between sports teams. In overseas markets, exclusive NFT products of top sports players can go for six figure numbers, and some can even be sold for millions of dollars. According to Deloitte, the total sports NFT transaction value was USD 1 billion in 2021, and the annual growth is expected to be 140% in 2022, making the sports industry one of the most promising NFT sectors.
- The applications of NFT are expanding. NFT technology can help resolve the issue of who owns digital property and hence improve the efficiency of digital asset transactions. Hence it is likely that NFTs are going to be widely used in future. Beyond their current use in collections, gaming and as artwork, the application of NFT technology will probably expand to include the financial sector, insurance, and even physical assets (e.g., housing and vehicles) and personal identities – for example, verifying housing and other real estate properties, driver’s licenses and items of personal identification such as academic certificates. In addition, the transactions themselves can be developed to become a sub-segment within the financial industry.
- NFT drives development of the metaverse. NFTs are also going to influence the fundamental transaction rules for the metaverse as they allows users to monetize the NFT products they create and transfer assets across platforms, which reflects the decentralized nature of the metaverse. The metaverse also makes it possible to maximize the value of NFT through immersive user experiences.
- Risks exist in the NFT market. Since NFTs are relatively easy to create, it is very likely that the volume of NFTs will be increasing significantly in the coming years. This can lead to the potential risk of a bubble. Meanwhile, the market is still exploring NFT business models. The major monetization method being used now is selling NFTs directly, or earning trading commissions in games or secondary markets. But much depends upon the regulatory environment governing NFTs and their applications, but so far the relevant rules and policies are yet to be developed and released.
A matter of survival for EV makers
Record high oil prices have not cheered up the Electric Vehicle (EV) industry. On the contrary, most electric carmakers have been plagued by price increases in raw materials, ranging from commodities such as oil, gas and coal to industrial components such as copper and aluminium as well as key metals used for battery production such as lithium, nickel and cobalt, which have all surged in price since the beginning of 2022. The spike in material costs is threatening to put a dent in the profit margins of China’s fledgling EV companies.
Take EV battery raw materials for example. As of Mar 8th, the price of battery-grade lithium carbonate climbed to RMB500,000/tonne and the London Metal Exchange (LME) nickel price increased up to a high of 50,905 US dollars per tonne, shooting up 525% and 207%, respectively, from the same period of last year.
Chart1: Price trend of lithium battery cathode and electrolyte materials
Chart2: Price trend of LME nickel price
Source: Antaike, LME
Even automakers that used to be well-positioned to fend off price hikes have started to feel the impact of inflationary pressures. But the effects vary among different EV makers depending upon their product mix, supply chain structure as well as their market positions. The EV makers targeting the entry level segment of the market have ceased production altogether as the raw material costs are biting deep into their margins. Mass EV makers have been able to pass on the costs to customers but fear of a demand slump made a few of the newcomers decide not to increase the prices of their EVs.
The short-term impact of price hikes remains to be seen. But a more worrying sign coming out of the price surge of commodities is whether it will push back the timeframe of electric vehicles reaching price parity with their petrol counterparts.
In this report, we intend to address three key questions: 1.) what caused the surge of metal prices? 2.) Will the price hike be sustained in the long term and 3.) What options are available for EV makers to navigate the “commodity super cycle” to get hold of the resources needed for their unfolding EV strategies?
The underlying cause of the rise in the price of metals is the imbalance between supply and demand. The growth of electric vehicles in the past few years has largely outpaced the expansion of capacity in upstream mines. Take lithium for example - some estimates show that global demand for lithium grew from 23,000 tonnes lithium carbonate equivalent(LCE) in 2015 to an estimated 260,000 tonnes in 2021, while global lithium production capacity only grew at an annual rate of 21%. The resulting demand-supply imbalance has put the market in a very vulnerable position.
Although analysts from the mining and metals industry expect prices of key metals will drop and flatten out when new mines become operational, higher prices are expected to persist in the long term. Many lithium miners, coming out of a multi-year bear market, are struggling to expand production capacities despite the surging prices. In addition, the complex global geographic landscape, the ongoing pandemic, the changing regulatory environment and increasing environmental compliance costs associated with mining have all hindered the pace of expansion of upstream mines.
So, if this price hike is here to stay, then what should EV makers do to secure enough resources at a low cost? Carmakers have resorted to various approaches to withstand the impact of a price hike storm. For starters, as of 2021, a lot of EV makers have forged close partnerships with upstream mines. These have taken the form of long-term contracts, joint ventures, equity investment, or strategic investment in order to secure the future supply of key metals. Moreover, EV makers who have established in-house battery R&D capacities have attempted to reduce lithium consumption through technology advancement. On the other hand, they have also made investments in technologies that enable them to reduce their reliance on rare metals. Finally, given the scarcity of nickel and cobalt, a more sustainable route could well be to establish a battery recycling system that extracts these metals from retired batteries so that the original materials can be recycled and used again. This will make the electric vehicle economy a circular one.
Life Science & Health Care
Answers to the issue of an aging population
With progress in medicine going hand in hand with rapid economic development, the proportion of the elderly in China (aged 65 and above) has grown rapidly from 7% in 2000 to 14% in 2020. This is expected to exceed 25% in 2050. Hence, all players in China’s LSHC market are now paying a great deal of attention to the challenges and opportunities arising from this trend. In the coming years, with the support of government policies, we believe that a slew of innovative solutions to the aging population problem will emerge as new technology powered medical care ecosystems will bring about further upgrades and expansions to the senior care and medical services in China.
Source: EIU, MIF, China Health Statistical Yearbook
Currently, there are two main driving forces behind the development of senior care services:
- Government policies supporting the development of the senior care industry
In response to aging population trend, the government has proposed more than ten documents that focus on diversifying and enhancing medical care facilities to provide services and facilities to support the care of the elderly at both the national and provincial levels. There are two key development areas: 1.) the creation of pension finance and insurance and 2.) the improvement of hardware and software in senior medical services.
- Investment in key areas will rapidly develop the senior care industry
Capital has poured into many pension related projects, and new medical solutions have been proposed to cope with the aging population. Cross-sector collaboration has also become more common. From real estate companies to insurance, financial institutions, and technology companies as well as Internet companies, all have established strategic partnerships with life science and health care companies to jointly build innovative senior medical care solutions while improving vertical integration within the senior care system.
However, as the pandemic lingers, senior care services in China face significant challenges. For example, door-to-door services need to be strengthened for those of the elderly who are living all alone or are disabled or suffering from chronic diseases. It is also necessary to speed up the reinforcement of in-home care, strengthen the construction of community care services, and improve both hardware and software in nursing homes. Meanwhile, the demand for professional senior medical care staff has grown rapidly, giving rise to the need for an urgent solution to issues that the senior medical care staff face known across the sector as the "three lows and three highs" (low social status, low income, low educational level and high labor intensity, high turnover, high average age).
On the whole, the “pain points” of China’s current senior care medical service are mainly manifested in shortage of talent, high costs, insufficient funding, mismatches between supply and demand, and insufficient standardized management. In addition, from the demand side, the elderly have yet to accept with the idea of "paying for" such services. Long ingrained habits of frugality and low-consumption make them unwilling to pay for anything but the most basic care.
Deloitte expects to see two major trends in China's senior care industry in the years to come:
- Smart senior care will become the new growth driver
At the present, there are two major models of smart senior care services - the "comprehensive model" and the "vertical model" - both of which are still in their infancy. From the perspective of the government, the development of the smart senior care service platform will reflect the transformation of the government's public service model. The smart senior care service platform will force different departments to integrate and can provide a refined, personalized, comprehensive and need-based public service. From the perspective of enterprises, "Internet + Internet of Things" will definitely bring in new business opportunities. Thus, with the gradual maturity of new products and technologies, we expect to see smart senior care become the major growth driver of the senior care industry in China.
- Models of "community-based senior care" will be developed and implemented
With the number of elderly who are living alone on the rise, demand for community-based senior care services (senior care services that are designed for a cluster of home-based elderly in the same community) is increasing year by year and government policies support and encourage the development of such community-based senior care services. The 14th Five-Year Plan for Urban and Rural Community Service System Construction Plan, issued in January, emphasizes the idea of "strengthening the functioning of community senior care services". At present, the community senior care mode has yet to be widely popularized at the national level, leaving much scope for development. With explicit policy support now being given, we can expect that senior care community development will witness further growth in the next few years.