Walled In: China’s Great Dilemma Presentations by: Yansee Mata and Jarrod Van Doren

Overview China’s Economy: Slowing and Slowly Rebalancing Presented by Jarrod Economic Outlook: Short, Intermediate, and Long Terms Presented by Yansee

Third Plenum of 2013 November of 2013, the Communist Party of China proposed reform: State-Owned Enterprises and the Private Sector Financial System Fiscal Policy Rural Land Reform and Hukou Reform Market Access and Foreign Investment Environmental Regulation

Economic Outlooks China’s leadership has the right ideas to achieve high and sustainable growth, the concern is that that is easier said than done. Pros: Second-largest economy PPP basis, the largest Cons: Rising debt-to-GDP ratio Less friendly global backdrop Vast and populous country Multiple interests

Short Term China’s goal of real GDP growth of 6.5%: Fixed asset investments: Manufacturing Infrastructure Real Estate Consumption: Unemployment VS Wage Growth Poor data: Migrant workers and unemployment benefits Service Industry and SOE’s Contribution to Net Exports Interest Rate cuts Reserve Ratio Public-Private relationships

Intermediate Term Base Case Scenario Alternative Scenario China will delay reform and achieve GDP above 6.5% for a few years but this will cause decline in TFP growth. A stimulus will increase Investment of GDP but debt will be at a high. Alternative Scenario Slowing the growth of GDP and credit. Reform would be introduced steadily to increase TFP from 1.6% today to 2.0% over a decade. Investment from GDP declines and debt grows at a slower pace.

Fiscal and Monetary Policy Intermediate Term Fiscal and Monetary Policy This can be achieved with an increase in debt and investment, and would produce wanted results for the first few years. It would then result in a decline in GDP. It will most likely not be the path taken due to China’s leadership. Implement Reform This path would result in a slower growth of GDP but would provide economic stability in the long run. The reason it would not be used is due to political and social instability. The Chinese Communist Party will want to guarantee it can remain in control.

Long Term A large and growing debt burden- If interest rates and credit growth do not decrease, China will continue to pay a growing share of GDP to interest payments. Diminishing export competitiveness- China has increased manufacturing costs over the last decade. Indonesia, Thailand, India and Mexico are now less expensive than China and Mexico has a proximity advantage.

Long Term The weight of history- Growth inputs cannot be replicated from what was done from 1994-2014. (Employment, Education, and Investment in Physical Captial) Persistent structural fault lines- China has low productivity levels but it is not spending enough on education to increase those productivity levels. What is spent on education is low compared to other developed countries. Two graphs overlapped.

Japan-Style Slowdown China’s starting point: Lower GDP per capita Demographics are less favorable Labor pool is not as educated Bigger rebalancing task Lower rank on business factors

Return Expectations 2016 Returns: If there are SOE reforms there will be deterioration in Chinese equities. Currency will also depreciate if there are rate cuts. 2016-20 Returns: Long term Returns: The depreciation of the Renminbi will bring down emerging market currencies.

Conclusion China has goals of reform to double GDP by 2010 and change the direction of the way its economy functions. The task ahead will be difficult and the next 5 years will bring market volatility to emerging markets. The U.S. will be impacted by Chinese reform and investors should be aware of these changes. Moving from export-drive and investment-led economy, to consumption-oriented economy.