The 3Ds of China’s economy

February 1, 2024

Woman in suit looks out at Shanghai skyline at sunset from window in building.

Contrary to the market’s expectations of a robust post-pandemic economic recovery, China’s rebound has been underwhelming. Although its 2023 GDP growth surpassed the official “around 5%” target, key indicators point to a struggling economy in the post-COVID era. This situation reveals three primary challenges: debt, deflation and demographics (collectively termed the 3Ds), reminiscent of Japan in the 1990s. China is arguably in a stronger position, with potential for higher growth, lower asset-price inflation and more effective currency management. Nevertheless, addressing these problems is complex. While debt and deflation could be mitigated through proactive government policies and a shift to a consumption-driven economy, demographic trends are less malleable.

The one-child policy legacy

For the second year in a row, China’s population decreased by 2.08 million people in 2023 after losing 850,000 in 2022. The longstanding one-child policy, only lifted in 2016, has had a lasting impact. Government initiatives to encourage marriage and parenthood have been insufficient. Educational and employment gains have empowered women to have more control over reproductive choices, contributing to a lower fertility rate. This demographic shift threatens China’s economic prosperity by reducing the labour force and consumer spending.

Balancing the productivity and social welfare equation

Globally, countries like Sweden, Japan, South Korea and Russia have tried various strategies to tackle similar demographic dilemmas, including financial incentives, and housing and childcare assistance, yet a sustainable solution remains elusive. For instance, Japan anticipates a shortfall of 11 million workers by 2040. However, this does not render these countries, including China, less attractive for investment. To adapt, China must improve its existing workforce’s productivity.

In 2022, household consumption in China constituted 37% of its GDP, lower than in Japan (55%) and the US (68%). This may be primarily due to the lack of a strong social safety net, leading to a high savings rate for healthcare, education and retirement. Enhancing these supports could unlock significant consumer spending. China’s government is transitioning the economy towards consumption, but pension, healthcare and unemployment reforms face political and fiscal hurdles. We believe improving social welfare is also essential for China’s economy.

Sector opportunities

Meanwhile, China’s equity market appears historically undervalued and relative to its emerging markets peers. After losing more than US$6 trillion in market capitalization since early 2021, it risks becoming a value trap if fundamental issues aren’t resolved. At the same time, certain sectors, like electric vehicles, renewable energy, robotics, healthcare, services and tourism, may enjoy strong tailwinds.

Fu Shou Yuan: A case study in market potential

An example is Fu Shou Yuan (1448 HK), a leading private provider of deathcare services that we hold in our Emerging Markets Small Cap Fund. Operating in 46 cities across 19 provinces, the company targets the premium market in a highly fragmented and regulated industry forecasted to grow at a 9% CAGR and reach US$56 billion by 2026, according to Goldman Sachs. Fu Shou Yuan’s extensive land bank, expertise and reputation position it to continue consolidating the market through tuck-in acquisitions and public-private partnerships.

China’s future amid the 3Ds

In the short term, investors in China are anticipating more impactful stimulus measures. We believe that for it to achieve sustainable growth, the country must simultaneously deal with its core structural issues and revive flagging consumer confidence.

Global Alpha Capital Management Ltd.
February 1st, 2024