China’s challenging landscape may reduce returns there, but will not stop the country on its path to economic development, according to a new white paper from
The Boston Company Asset Management, an equity manager within BNY Mellon Asset Management.

Threats to China’s continued growth and attractiveness for foreign investment include inflation, a potential real estate bubble, misallocation of capital, a poor demographic profile, and widening wealth dispersion, the white paper says.

However, such hurdles will not derail the Asian giant from its “development as a leading global economy,” says The Boston Company, but may weigh on margins, as inefficient management and a lack of transparency reduce returns.

"Good economic growth does not always mean profit growth, and investors should take note of China's changing landscape," said D Kirk Henry, senior managing director, senior portfolio manager at the firm, and co-author of the report, China at the Crossroads. 

Growth, inflation

China recently ended its interest rate tightening campaign, aimed at curbing inflation, over worries of slowing domestic growth.

In the third quarter, China's gross domestic product expanded by 9.1 per cent from a year earlier, compared to 9.5 per cent growth in the second quarter, according to MarketWatch. Meanwhile, Yu Yongding, an economist at the Chinese Academy of Social Sciences, described inflation as “under control,” and said he expected it to be below 5 per cent by next year, according to the publication.

This process is “a difficult balancing act that requires targeted policies to contain the frothiest industries, such as property development, without jeopardizing local demand for basic goods and services,” said The Boston Company.

Inefficient management

A striking example of inefficient capital deployment is the credit-driven over-investment in housing and construction, which has caused the home price-to-income ratio to leap to 20 in Beijing and 16 in Shanghai, compared with six in the US at the peak of the real estate market, the report says.

On the upside, new housing supply is being concentrated in “Tier II” cities, says The Boston Company, which have been subject to less speculation than Tier I cities, and where demand will be buoyed by an influx of some 10-to-20 million rural-to-urban migrants annually.

"Housing is just one example where China faces challenges," said Henry. "We believe that China ultimately will succeed in overcoming these hurdles, but not with same government control and unproductive capital allocation that we see today."

Government controls

Further question marks hanging over China’s growth include whether the country’s future leaders will be more “authoritarian than the current group,” the report says. If so, this could further undercut efforts to open up the economy and raise living standard for the poor, it continues.

Meanwhile, efforts are needed to tilt the economy away from exports and encourage consumption, as the developed world continues its deleveraging process, the report adds.