Evaluating and Gaining Access to China’s Private Markets
Our panel of experts shared their insights on China’s commercial real estate, private equity, and venture capital markets.
Given the sheer size and potential of the world’s second-largest economy and capital markets, institutional investor interest in increasing allocations to China is no surprise. However, investing in China is not without its risks, particularly when it comes to the country's complex debt overhang.
For the Winter 2021 installment of the PGIM China Investment Symposium series, we brought together a global panel of experts to examine the dramatic rise in China’s debt over the past decade and the implications for investors. Other topics covered during the session included:
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>> Good morning. Good afternoon. And good evening. My name is Keshav Rajagopalan, and I'm a member of PGIM's Institutional Relationship Group. Thank you so much for joining today's PGIM China Investment Symposium event, the seventh installment in this series. I'm very excited about today's event because we're unpacking the all-important and very complicated topic of systemic leverage in China and whether China's debt is too big to fail. And the subject couldn't be more apropos because just earlier today, Fitch's Rating announced that both Evergrande and Kaisa, the property developers in China that are often in the news, were put into restricted default. While this was often expected and really it was going to happen, what we want to do today is really go deeper and unpack this very, very complicated question. I'm excited to be joined by four excellent panelists to help us tackle the issue. And today, this issue becomes even more important as those of us in the Americas and Europe can't travel often to the region to see what's happening on the ground there. Two panelists, my colleagues from PGIM Fixed Income, Gerwin Bell, our Lead Economist for Asia, and Aayush Sonthalia, our Emerging Markets Debt Portfolio Manager. Calling in from Asia, we have May Zhong, Head of Corporate Ratings at S&P Global China, and Hongbin Qu, Chief Economist for Asia for HSBC. Thank you all for joining today. With that, I'll begin our question on our discussion first with a question to Gerwin. Wanted to start as we open up just with the macroeconomic backdrop. So to kick off and set the stage if you could provide a little bit of background on China's post-COVID economic recovery. China was obviously the fastest to recover, but now there's been a lot of -- a lot of talk of slow down and maybe even heading down. So really, if you could get us into what are some of the underlying causes and also the implications for the global economy.
>> Good morning. Good afternoon. Good evening. [Inaudible]. And thank you for whoever organized this panel construct. [phonetic] I mean, it's really a pleasure having such high-caliber co-panelists. As you said, it kind of makes up for the fact that, unfortunately, we couldn't do it in person. But I mean, my co-panel is of such a caliber that I'm actually basically here to learn. But since the first question is to me, let me try to answer it in a few broad strokes. You're right. Everybody knows China was the prototypical first in, first out with the pandemic recession. But it is also quite literally the mirror image of what we have observed everywhere else in the rest of the world. So what do I mean by that? In contrast to what we know in the rest of the world, blanket and fairly harsh and wide-ranging lockdowns was imposed that substantially impaired production and the supply side of the economy. China, in turn, actually prioritized production way early on, as much as -- as early as after the Chinese New Year in 2020. And then particularly another big key difference is in particularly in developed markets. The effects of these lockdowns were thought to be buffered by large scale, very large scale. And then historically unprecedented fiscal transfers to [inaudible] in corporates in order to make up for the income loss from lockdowns. That did not happen in China. China was much, much less, we want to be, I want to call it generous in terms of providing transfers to [inaudible] and firms. That situation then left the rest of the world with a very large excess demand. I mean, they had very buoyant demand supported by transfers and fiscal stimulus by production came to a standstill pretty much. China, on the other hand, had early on brought production back. And China is still being, no matter what you heard about trade war, China still is the global factory. Had scope to meet this global excess demand via exports. The first round of exports for China was indeed centered on pandemic goods, for instance, in masks and PPE equipment. But subsequently, the Chinese exports are said to have broadened [phonetic] into a wide range of goods. And you all know this, I mean, service demand in developed markets was replaced by what the economists call home production. When you go and do your -- buy a new backyard grill, you buy a Peloton, or you need to do working from home electronics or buy gaming systems for the kids. All these things that were substantial manufacturing component in China. So in the bigger picture then, and that's really important to notice was that's something that we haven't seen in a while. This is the first time since the global financial crisis that China is not the locomotive of protocol. [phonetic] Instead, it is the developer that drives the global recovery and global goal. [phonetic] China mean [phonetic] by registered very large trade surpluses and export-driven growth benefiting from the global demand force. [phonetic] And for the first time since the 1980s, you have to go that far back, United States has outgrown China sequentially this year with 6% growth for the third quarter, compared to China's less than 2% growth. That's a huge change in the in, in the global economy. Now it is quite important, our starting from here that this needs to change if China comes anywhere near its growth targets next year. Chinese growth in 2021 benefited from a very strong statistical carryover. This just means the growth that you would have -- that you would have recorded had long, not no growth at all happened in 2021. Just on the basis of the very low base established in 2020, China would have registered an annual average growth rate of 6%. That's unique to that [inaudible]. Without any growth, China would have grown 6%. So the 8% growth rate that I have penciled in for 2021 is really not much more. Now coming to the second part of your question, why are things slowing right now? I think that probably Hongbin has just a much deeper insight in this. I think the Chinese authorities seized on this favorable external backdrop to address some of their earlier stability questions as it were related to debt, to housing costs, and social issues, and income distribution, the cost of medical care. And they could do focus -- they could focus on these issues even at the cost of lowering growth since one, the external demand picture was [inaudible]. And secondly, since for statistical reasons, the baseline growth was already so flatter. Now, what happened more recent is that markets became concerned when the Chinese authorities targeted the property sector and property developers for a somewhat targeted reduction of their debt loan. [phonetic] Given the very outsized growth of the property sector in China, it's of much higher importance for the economy, pretty much anywhere else in the world. That carries risk. Moreover, now we have the reverse carryovers in sight. So if the growth, yeah, that from 2021 that we carry over into 2022 right now, it's practically nothing. It's between 0 and 1/2%. So if the Chinese authorities really want to make a 5% growth target next year, they will have to impart much greater stimulus than they have so far shown. And I think markets are looking and waiting for that to happen.
>> So Hongbin bringing you in here, you know, I think Gerwin painted the backdrop of, you know, maybe a structurally changing global economy. What does it look like 12 to 24 months? What are some of the things you're thinking about and seeing on the ground there?
>> Yeah, I totally agree with what Gerwin just basically laid out in terms of China first thing for a start in terms of the, you know, software dependent. Again, they reopened the economy. And actually, guess what? China is also the first government to proactively starting to normalize its policy or to even they could take one step further, try to address this kind of structural issues like, you know, higher leverage [phonetic] issues in a number of areas, particularly in the, you know, property markets. Now, although, you know, the exports do remain pretty resilient for time being, but we all know that, you know, going into next year, you know, the spending there's kind of fiscal stimulus [phonetic] kind of driven, kind of those kind of the [inaudible]. A strong rebounding, you know, Western world's kind of consumer spending, it's likely to lose some steam. So the exporter -- is just matter of time for export will be the last bit of steam. [phonetic] And then on top of that, you know, as part of -- as a result of those kind of the, [inaudible] property-related landing, kind of the regulations, and then the property has been slowing. And that also basically take its toll in terms the most of the amount. But given government, as I mentioned on the property sector, is one of the major kind of the most of sector in China. So the combination of they kind of anticipate the slower export growth, plus this kind of the weaker, the most demand means that China probably it's a time for the Chinese authorities to rebalance its focus in terms of the policy targeting. In other words, I think from now, you know, from now, you know, going forward I expect the policymakers to per our ties be, you know, to stabilize the growth or even try to basically to engineer a modest recovery in the kind of the most of the amount in order to basically to make sure that there is enough GDP, enough economical activities to generate enough jobs for the, you know, for the young people. And the, you know, the job pressure actually, you know, recent amounts is the result of the pretty fast slowdown, you know, in the economical activity. And the job pressure has been rising. This is actually against basically mirror image of what happened in the Western world. Everybody in the US is worried about, you know, tight labor market and the wage inflation. But in China, it's the opposite. And the authorities starting to worry about the, basically, the, you know, the labor market is like. So, as a result, I think I expect them to step up the, you know, the policy easing. It's not necessarily kind of the reverse, complete reverse in terms of the, you know, the process of policy normalization that has been doing since the beginning of this year. But they will start to basically to do what they call the targeted easing imposing in terms of monetary and the fiscal parts front, in order to basically to support these selective areas. Where are the basically selective areas in terms of the most of demand? There are three kind of areas, which are, in my view, over the next 12 months or so the government's kind of the, you know, target [phonetic] the ease and likely to, you know, to focus on. The first area is going to be the higher-end manufacturing sector. They know that, you know, the property market is not good. You know, they can no longer rely on the, you know, a rebound in the property market. So basically, to drive all the growth in the most demand. So, therefore, they need to cultivate a new alternative of growth drivers. The high-end manufacturing looks like it's going to be the one of the most likely kind of the new growth driver they're going to do. And in fact, you know, in the recent the weeks, the PBUC [phonetic] has already basically [phonetic] to step up the, basically, the selective easing to encourage the base, [phonetic] to inject more liquidities to the banks, and then to encourage the city banks to increase the credit support to the manufacturing sector, yeah? And the second kind of area, which I think this kind of target easing is going to focus on, is actually the green investment. I expect Beijing to really to jumpstart the, you know, the need of the green investment next year to basically to, you know, to hit two stones -- hit two birds with one stone, which is basically by jumpstart the green investment. This is kind of the investment China need to do this anyway, you know, in the next five to 10 years at a time when you, you know, need that boost to get the most demand. Why now to front loading some of this need of the project. And then you, you know, near term, you basically generate enough kind of the, you know, short-term investment demand. At the same time, you're also basically, you know, starting to prove the way for you to hit the climate goals, which Beijing has taken very seriously. You know, in the recent -- in the recent -- recent amount. They set up very specific, concrete target for every sectors in terms of how to achieve the, you know, the climate target for the next five to 10 years. So next year actually is the good time for them. And to kick, jumpstart this kind of needed green investment. And so, actually, all my team basically has been working on this. And then they basically figured out that probably, well, we are looking for some sort of the, you know, over 30% kind of growth in green investment next year. So the combination of the basically acceleration in the CapEx in the high-end manufacturing under the, you know, a jumpstart in the green investment, which is likely to lead, [phonetic] basically the modest recovery and the most demand in the next 12 months. That's likely to basically to help to offset some of those headwinds from the, you know, slow export. And also, they continues kind of the muted kind of the property activities. And then, as a result, I think actually we like -- actually we like to see probably kind of the, a gradual recovery or a modest rebound in terms of China's growth, probably starting from the, you know, second quarter next year. Of course, you need to give them a bit of time for this new policy in the initial to phase through. So starting from second quarter, next year, we think the growth are starting to base bottom out. [phonetic] And then into second half next year, we're really looking for growth rate this kind of real kind of growth without this kind of basic fact. [phonetic] The real growth rate in terms of GDP, we're looking for something getting close to 6%. Currently, with [inaudible] talk about the growth rate something between 3 to 4%. So, you know, if we get close to 6%, we're talking about something like 2, 2-1/2, to 3% of performance [phonetic] kind of the pickup in terms of the growth rate. It's not really a V-shaped recovery, but nevertheless, I think is still kind of the, you know, these [phonetic] in the kind of the recovery. In the, you know, kind of the on a comparative basis particularly we looked at basically the challenges in another [phonetic] emerging markets going to facing in the next kind of 12 to 24 months.
>> All right. It's very helpful. You know, it sounds like definitely an economic transformation there. And global implications wise, China may no longer be the growth engine for the global economy. And I think, you know, May, bringing you in now, there's an economic transformation underway, but there's the twin effect of obviously the social and regulatory transformation underway as well, you know, President Xi's Common Prosperity Initiative. What are you seeing from a regulatory landscape overall, especially from your seat, as you think about corporate ratings and information and just the landscape in general? How are you all thinking through some of the actions that are taking place there?
>> Okay, thank you. Quite often, being the analyst on the ground in Mainland, quite often, I get asked by overseas investors about the policy and regulation in China. And one of the feedback they or the comment people ask me is, well, there is a level of uncertainty. How we should anticipate what will come next? So here, I'm going to share with you some of the sentiments from investors domestically in China. They have a slightly different view of these in regards to regulations and policies. In summary, the direction of these policies that we have seen recently may not come as a surprise to most of the investors domestically. That said, the magnitude and timing of these policies came as a surprise to domestic investors as well. And in other words, people see the trays [phonetic] of them coming from various government speeches or news. So people do see that coming. It's just they didn't expect that it would come so soon. And the consensus view from local market is that some of the triggers for the recent government's action is to achieve the goal of common prosperity. In that context, the new driving force of this country's economy in future are from the following areas like anything that can help improve people's livelihood, for example, education, housing, and age care, ecology, science, and technology. And that's why we have seen policies being released around these industries in China in the past 12 months. For example, the reform on medicine procurement, the purpose is to reduce people's medical bill. And also, the policy on tutoring is to reduce the education burden for normal people. So, and also the other thing we should understand is when China look at a policy, they normally assess that from the perspective of the whole economy in the longer term. Therefore, they could live with a short-term pain on some sector for long-term gain for the whole economy in the longer term. And also, they have a strong ability to implement these policies. So, for example, the recent Communist Party Committee's Sixth Plenum also reinforces the continuity of the policies that could achieve their goal of common prosperity. And interestingly, common prosperity is not something new. It was the communist party's target a hundred years ago when the party was founded. So I will stop there and back to you.
>> Thank you, May. And I think that's a perfect backdrop between economic and social policy. And it really brings to light the fact that those of us in the Americas, Europe, we can't travel there. What we read and hear about is so different from what's happening on the ground. So thanks for shedding some light. Aayush, now coming to you. You're a portfolio manager that looks at this stuff and thinks about ways to, you know, put money to work in emerging markets, debt. Real estate and the trouble in the real estate sector, Evergrande, Fantasia, Kaisa obviously are in headlines. How are you thinking about the overall debt [inaudible] picture in China and coming to that topic of a systemic leverage? [phonetic] So what are the -- what are some of the concerns, opportunities, challenges you're seeing?
>> Thank you. And good morning. So China is the worst-performing country in the EM high-yield offshore bond market. You know, with the stresses in the property market, you know, the average yield on those bonds is near to 30%. So effectively, what that means is that the offshore bond market is shut for Chinese property, you know, the private issuers. Now the challenge is that there's a maturity wall, so there's $40 billion of bonds coming due in the next 12 months. And you know, with contracted sales in the property market down roughly 40% year-over-year and prices having basically stagnated, there's a cash flow issue. And Evergrande and Kaisa, you know, they've just, you know, just not being able to gather the funds to essentially pay off the maturities. However, there are some names, for example, Sunec, [phonetic] who's been --
>> And May, coming back to you then, do you kind of, you know, stepping back, see a contagion concern? You know, I think Aayush touched on the offshore bond market. What's happening onshore, including kind of sovereign quasi-sovereign debt and some of the local, you know, government financing vehicles and other sectors, maybe?
>> Okay. So I'll firstly comment on those sectors that has close ties to the property sector. The first one is engineering and construction. I would say that the impact will be limited due to those reasons. One is the engineering and construction sector in China, there are two largest exposure. One is infrastructure construction. The other is property construction. I would say that the exposure to infrastructure outweigh the exposure to property. So that's number one. And number two, more importantly, is the delivery of presale houses is the top priority for any property developer now, even for those that have defaulted. The government has a close eye on all the developers to ensure that they can deliver the houses to people who already prepaid. That's why the government locked down all the accounts with the presale proceeds. And the money can only be used to complete the construction. So, in summary, that's why we think the E and C [phonetic] sector will have limited impact. The other one is building materials. And thanks to the supply-side reform started a few years ago, that put a -- that constrains the new capacity growth. So even though the demand could moderate next year, we will say that the supply side will continue to be tight, in particular when the governments push to achieve carbon reduction targets. So that's why we expect the prices could remain relatively high from a historical level for those sectors. That said, the only sector that could be affected indirectly from the slowdown in the property sector is LGFV, as you mentioned, those quasi-government bonds. This is because proceeds from land sales are important revenue for local governments. And if you think that with the tightening in funding, in the property market for property developers, they will firstly prioritize completion of the apartment construction followed by interest and principal payment. So the last one on their to-do list is to land -- is for land acquisition. That's why we expect that the willingness to purchase more land in the next 12 months could be much lower compared to historical years. In other words -- And also it will -- most of the property developers, they could focus on their core cities, like the tier-one and tier-two cities. So, in summary, this too could result in softening in the process from some of the regional governments. So that could reduce their financial flexibility to support local government funding vehicles. That's why we see that the gap between the local government funding vehicles among different cities could widen in future.
>> Thanks, May. And Gerwin and Hongbin, coming back to you now and just kind of tackling that systemic leverage question. Gerwin, starting with you, you know, what's kind of the hawkish view here. What concerns you about debt overhang, or is this a Minsky moment when you kind of look at the debt markets in China and kind of your take. And then Hongbin, maybe providing a bit of a counterpoint to Gerwin on kind of dovish views. What's the opportunity and bring a little tension into this dialogue.
>> I don't like hawkish, so let me give you what I would call the skeptic's this time is a lot different. And my point of departure is the foreign. [phonetic] So in the 12 years up to 2008, China's debt to GDP stock [phonetic] rose from 100 to 140%. And the little more than 12 years since it has doubled, it's more than doubled to 280% of GDP. So there's been a sharp acceleration in debt dependence. [phonetic] Now why is that? And it like micro-based to look at this, but if you come from a practically due [phonetic] stationary perspective to look at this, I mean the analysis comes up with it's a result of potential growth being lower than the targets that the authorities have set themselves. So then, in order to meet the actual growth targets, you need to lever up. And you need to target areas so that they're easy to give policy tools such as infrastructure, investment property in the long term. But all of these are highly, highly [inaudible]. The second point is that that part has not at all been lost on Chinese policymakers. I mean, they are very, very worried about the drastic increase in debt. And they have at least had since [inaudible] episodes where they're trying to reign in the dependence of the economy only to abandon when the growth costs became very clear. And again, the point there is that an acceptable, [inaudible] acceptable growth level seems to be higher than what the economy can generate potentially without incurring additional debt. So the bad news is that, you know, that's all not this time it's not different. That's sort of an assessment that you kind of have to make on the basis of one microeconomic analysis. The bad news is is that the potential growth may be slowing further. That's both as a result of the traction [phonetic] of Chinese -- of the Chinese authorities on China's homegrown and in many ways, bird [phonetic] beating [inaudible]. I mean nowadays, I mean, I see in New York people put their phone. And they're being able to enter the software being [phonetic] by phone. I mean, that has been the practice in China for more than a decade. I mean the -- many Chinese tech companies were first. They were actually genuine innovators. That innovation drive, though, seems to be at risk from political agendas trying to reign in the tech sector pretty much like it has been happening across the world. So that's step one by Prudential Growth Media. [phonetic] Of course, the second one is the US-China, or perhaps why the Western-China technology conflict. There is a risk that there's a real decoupling in the technologies space and particularly that it will be increasingly hard for China to import high productivity and highly advanced technology equipment. That will have [inaudible]. No beyond that, the IMF has estimated that China, still on average, only operates at some 30% of the global production possibility front. So if 100% is the best way you can potentially produce in the world, China is a third. And [inaudible] sectors said the trend has actually worsened recently. And there's a lot of work to be done in China in lifting potential growth. But that seems to be politically hard. I mentioned the tech sector crackdown. I mentioned the pushback of the rest of the world on the tech sector imports. I mentioned the continuous preferential access of the SOE sector in China to scarce credit. And the SOE sector, by and large, is significantly less productive than the private sector. And moreover, this is -- this whole middle-income trap, are you ever going to be able to get out of there, probably is not a new one. And we had a number of countries in Asia that confronted the same problem, Taiwan, Korea, notably Japan as well. But what we've seen in all these countries at roughly a similar point was a major political change. That seems not to be in the offing in China. So our baseline is we will not get these productivity-enhancing reforms. But instead, we're going to get rising debt again, albeit in a stop-and-go fashion. So if you have a chance to rely on a favorable external backdrop, there's going to be less standard in relation. [phonetic] But if roles needs to be boosted, there will be more in particularly in selective policy-driven areas, like Hongbin mentioned, the high-tech sector, the green sector. The key point there is, these are all probably very valid points. But they cannot replace the animal spirits that typically lie at the root of deep, deep productivity improvements and have so been in other Asian countries. So, where does that leave us? I mean, for investors, this is actually not necessarily -- fixed-income investors, I should say -- this is actually not necessarily a bad environment.
>> China needs to have lower interest rates and actually lower interest rates if only to lower the implied interest burden on the economy. Just so, as an example, average interest payments on an annual basis in China in the last year have gone between 12 and 15% of GDP. That exceeds nominal GDP growth. So in order to meet your interest payments, you already have to borrow. That is not a very sustainable level. So we see a need for interest rates to come down in China, which is a nice thing for capital gains for fixed income [inaudible]. Now [inaudible] method. And probably this is not a hawkish one, but ultimately that system stands and faults [phonetic] with the willingness of Chinese households to own their very large savings still onshore and especially in bank deposits. So this is not the normal emerging market where you see the debt explosion. And you fear sudden stop of foreigners [phonetic] in advance of payments prices, no, the Chinese, the large Chinese debt is offset with large Chinese savings. But these savings need to stay onshore. And households need to be confident to keep a savings in, for instance, property in onshore vehicles. If that were to, that confidence in the Chinese saver were to take event, then that would be a more problematic level. A final point, against is like, I get this question a number of times. I've actually written a white paper on this. Will China be overtaken with the US GDP level? It's, you know, not guaranteed. So that's something that may be coming up in the next three or four years. And how come China's promise to become the largest GDP in the world is addressed. So I leave it there. I hope that was hawkish enough for you, but I hope it was also somewhat [inaudible].
>> No, it's good points, and skeptic is the right word. But Hongbin, what are your thoughts?
>> What are you seeing? And is there a different thesis here to lay out?
>> Yeah, I will try my best to try to disagree with Gerwin.
>> Yeah, we want disagreement, that's always [inaudible].
>> Okay, great. Look okay. You know, I'm not sure. I think there's a -- the market is kind of those concerns about China since [phonetic] medical reasons, China's state. I think it has been seriously overplayed, you know, for a number of reasons. First of all, I think Gerwin kind of, you know, mentioned that point, which is that I mean China, yeah. China, 270% of GDP, which is, you know, which is, it's not the highest, but not the lowest kind of level. So it's unique [phonetic] and the high end of the global, if you put it in a global context. But however, I think that there is a nimble [phonetic] for factors, which means that China have more room than not a highly leveraged countries try to basically maneuver or try to basically refinancing its debt, current debt, yeah? One thing is obviously China is kind of the extraordinarily high, the most deceiving rate. [phonetic] If I'm wrong or if I'm right, I still remember China still ranks as the second highest, the most saving rate just after Singapore. We're talking about -- still talking about something like, you know, 43%, we used to be 46%. In my generation now with my generation starting to, you know, to basically to sideline date and the younger generation seems happy to spend a bit more. I know that from my children, so. But still, you know, we're still end up with kind of the well above global average. So as long -- I think the, at least, you know, foreseeable future, you know, those kinds of saving rates, there's a lot of factors there. It's partly because culture, partly because this, you know, different system. I think it takes time for us to see this high saving rate really to, you know, to change the picture. So given there's a highest saving rate, and also given the fact that China, luckily enough, China has never be take the advice from the, you know, I'm from the US American economies wholesaley [phonetic] to free up its capital account. So the capital account so far is still very manage of the capital of account. So with the high saving rate and the ways of relatively kind of the manage of the capital account, which means that you have a plan tier [phonetic] of the savings in the system. So that give China much bigger room to maneuver in terms of try the restructure that, [phonetic] yeah? And also secondly, talking about that refinancing that restruction. [phonetic] And the third crisis happens when you have this kind of, you know, panic where everybody try to, basically, when you see, you know, just in case I ever because it's just like the latest case Evergrande. When you see, you know, people worry about the, you know, the liquidity crisis [phonetic] and then the banks, every banks inside [inaudible] try to provide additional liquidity, try withdraw liquidity. So that sort of panic around is basically the maxims [phonetic] for you to call that crisis. So in China's case, who is [inaudible], who's the borrower? Mostly the government, either the local government through the, you know, local government financing vehicle as May just mention or SOEs, yeah? And SOEs take a full part of this corporate debt and then borrow from whom, who is the base, [phonetic] who are the lenders? It's the banks. Who owe the banks? State government owe the banks. So [inaudible] is the same guy from live tour [phonetic] to lend from left [phonetic] pocket to right pocket, which basically all nothing is [phonetic] being equal and which make it easier for them to co-organize [phonetic] this kind of restructuring, yeah? So I think the case [inaudible] here, or whether there's going to be, you know, bank, the bank is everybody's going to stop the lending to the door. [phonetic] I mean, even the latest case Evergrande, all these things, you know, we get those, this, you know, kind of cases. And then people worried about the systematic credit crunch. I keep telling the press, [phonetic] I said relax. There's not going to be a systematical credit crunch for the property sector. Why? Because all it takes once the government see the risk, potential risk for the systematical kind of credit crunch. All it takes the government to give it a phone to call the basically, the CEO of the Bank of China. Hi guys, go out to land to the, you know, these property developers. I'm pretty sure I can tell because I used to work for Bank of China. You know, I know those my former colleague. They always lost second store. [phonetic] They just basic go out to land to this property [inaudible], yeah? So yeah, you can -- you can criticize the system, but I have [inaudible] in a scenario way you talk about the manager, that's kind of, you know, the liquidity [phonetic] stress. I think that system is really helps a lot, yeah? So, that's basically the second important piece, [phonetic] is the SOE owes less than a state government. Of course, you know, the banks, you know, city banks where the banks' money come from is probably interview [phonetic] 1.3 billion Chinese. So the question here is now the way, if you basically try to, you know, paint other scenario way [phonetic] 1.3 billion Chinese or for some reason, there's no longer trust the, you know, the state hold banks. And then we are trying to have a big trouble. But, you know, as far as I can see, I can't see that sort of scenario. I mean, you know, why if I, so far, if you basically, May, she's sitting [phonetic] in Beijing. I mean, I get my friends, a lot of my friends in China if I ask them if anything, you know, despite all these challenges, pandemic, everything, all this kind of the negative news about China, actually the survey among for the, you know, all this kind of local, ordinary grass root people. I mean, they're kind of the confidence on the local -- on the government actually is get even stronger, rather than get weaker. So I can't see, you know, what could be the trigger for really it takes a lot of the, you know, imagination for you to see the scenario where all of a sudden in the government, in the Chinese government don't trust that. So that's basically -- that's basically their favorite cognition. And also, that going forward, I think they've also, the government also mentioned why, you know, or some overlap particular over since the global financial crisis. You know China's GDP ratio has rise much faster than the in the previous decade. I think there is a very good reason for that. The reason being very simple. Before the global financial crisis, which is very simple, Chinese basically, you know, use the savings to make the investment to build the capacity in a manufacturing law [phonetic] and the manufacturing sector. And then they basically pin [phonetic] themselves to the work factory. They produce this other stuff, everything from umbrella to some kind of, you know, mobile phones and then sell to the you guys, sell to the Western, you know, consumers. And then the Chinese guys lure [phonetic] these kind of a hot [phonetic] dollars. And guess what? And then, they basically receiving that, reinvest that dollar into the, you know, US Treasuries, yeah? And then the trend is for reserve, you know, pick up from 400 baling [phonetic] towards some kind of full trailing [phonetic] at the peak, which right before the financial crisis. And then the financial crisis, a wake-up call for the Chinese authorities. And look, you know, you know what? They're trying, in the US Treasuries is not as safe as it is be told, you know, for a long time. So they say maybe, you know, we should think about this. We should reassess of the risk of this parking, of kind of the, you know, excessive savings into the US Treasury. So they said, okay, maybe we should recycle all kind of savings to the dominion of the Muslim market. [phonetic] That's why the idea is, why not we just deploy [phonetic] our savings into some sort of long-term projects, yeah? Which in the near term may not make based on the retain the near term but is good for the long-term development. And then that's why this kind of the, you know, the wave of those kind of the instruction investment has be based, so they come to the picture right off the global financial crisis, yeah? So try not just give you a one simple number, which is that you know, 20 years ago there's only promise I mean less than 10 cities in China have a subway. But candidly now, by now we got 35 cities now have the brand-new subway in operation, yeah? This is a law. So over the last 20 years, you have more than 35 cities. They basically rule on the subway system. [phonetic] So why try not become the world largest consumer of the commodities, yeah? It's not game over. I think in the peak -- probably in the peak of this construction boom is behind us because you already have 35 cities build the subways. Despite that, I think that there's still some room. For instance, China still have, China in total have been, China have 600 cities, yeah? And of which they have more than 55 cities have the population more than three million. So, although we have 35 cities already have a subway, you still have 20 cities. We currently have more than three million people which not yet have a single live subway. [phonetic] So you still, over the years, you still have some room to do that. So and the key point here is this subway of when you build, when you spend the money to build a subway, which is basically majors measure, who are they financing with? How that's going to finance is mainly through the local governments.
>> Whether that's through local government's balance sheet. So, and then if it's local government, try to base a set up or a local or financing vehicle, a corporation. And then this corporation go to the banks to borrow, yeah? And then they invest in the long-term [phonetic] investment. So only, you know, behind this kind of the trading dollars of those in the liability of the LRG [phonetic] FB, which everybody's talking about. On the analysis side of SIMCON, [phonetic] I set side is basically all those kind of brand new sapele [phonetic] ways, high-speed rail, which are the layer of the insurance, [phonetic] yeah? In the near term, I way [phonetic] everybody knows that you don't know when can expect the, you know, the any kind of the subway system in any cities in the world by to make a high retain, near-term retain by just selling the tickets, yeah? But we all know that if you take a longer, you know, in the 20 years, 30 years timeframe, there's a kind of subway instruct, very basically instructs that should have a spin over effect, spend over effect, post-stimulus [phonetic] spin over effect for the productivity in the private sector of a local economy. So like, I my -- my question how to say this case last. [phonetic] Yes, they, you know, over the last 10 years, there is a faster build up the -- of the local governments and the [inaudible]. But that then was matched the way it's basically accumulation of this long-term assets. And those long-term assets is going to help, very helpful over the next 10 to 20 years to basically to improve China's productivity. At one particular point, I didn't want this for your ways they carry is basically the assessment of the continuous slowdown in China's potential growth rate, which actually, I'm not quite sure about that. So the, you know, conclusion, but in the country, given that the China is already pull this kind of a long-term asset, like subways [phonetic] instructure. [phonetic] And that talks that also China make a massive investment in education. Higher education has been, has also [inaudible] and now in the coming years, we're going to see the high education investment over last decades starting to bear the fruit. So the Chinese University, each year over the next 10 years, is going to produce nine to 10 mail-in [phonetic] universe, [phonetic] fresh graduate every year. And then more than -- nearly half of them is going to be majored in the STEM, yeah? In other words, we're talking about something like four to five million a year of new supply of this STEM graduate in China. I think that's going to be very, very powerful structural falls [phonetic] for China to upgrading. They take the knowledge. And then to move up the global volume chain. [phonetic] And that's going to be very conducive for the productive growth in China going forward. And then, you know how to [inaudible] this debt, how to refinance this debt. I think given China enough time, as long as the productivity continue to improve, I think now probably, you know, given them enough time, they should be managed basically gradually to manage it to refinance or solve this [inaudible].
>> Aayush, I wanted to come with you -- come to you for investment implications. You know, we're hearing themes of economic, structural transformation. I think you've heard two different views on kind of growth trajectory. How are you positioning portfolios for the long term? I mean, the one thing I hear from investors across the board is more and more appetite for China. In a low-growth world, China still is growing and growing faster than the rest of the world. So that is out there, so whether it's equity, debt, private markets, there's appetite for China. How are you thinking about debt portfolios and some of the emerging market strategies you run?
>> Yeah, honestly, for us investing in the offshore Chinese dollar market, it's been a very tough year. And we've gotten squeezed from both sides. I mean, Gerwin mentioned the geopolitical issues. So in November of last year, we had the Trump executive order where, you know, they blacklisted a whole bunch of companies, you know, which were linked to defense. And many of those companies, in our view, were not really linked to defense, like ChemChina, for example. And we were required to sell those bonds within a period of one year. Now President Biden has diluted some of those provisions. And that list has been narrowed to a much more focused defense list. So at least that pressure has been relieved on some of those bonds in the original executive order. And then we've had the stresses build up in the property sector. And unfortunately for us at PGIM, we have not really been involved in the Evergrande, China Fortunate Land, and Kaisa, et cetera. So shout out to our credit analysts, you know, located in Asia. How we're positioned right now is we do think that the market already is factoring in a very bad scenario, for example, for the property market. So, we do have a diversified approach, and we do have exposure to the Chinese property sector. But it's in the better-capitalized names, the double B names, like the Sunac, Agile, Logan's of the world. And in portfolios where, you know, these names or the sector is in the benchmark, we've had an equal weight approach, but we're starting to have an [inaudible] right now because of this recalibration of the policy. So you've gone from a very, very tight policy of financing to the property sector to a policy now where they recognize, you know, the importance of the sector to the overall economy. And you know, we are starting to see some on the margin relief in terms of the local financing being made available. The issue is the contracted sales are still very weak. You know, from an end buyer perspective, you know, the confidence is not there yet. But hopefully, you know, getting into next year, you could see some sort of sequential improvement in contracted sales. So we're, you know, we're moving from an equal weight to a slightly overweight leaning view. And we're targeting the better-capitalized names. We have not been in the Evergrandes and Kaisas of the world. We don't intend to be because in the restructuring, what's going to happen is that, as May Zhong mentioned earlier, they're going to prioritize the delivery of the apartments as opposed to any recovery to offshore bondholders. And there's no government bailout happening, which is very clear.
>> Very helpful from an implications perspective. Maybe for one final question, I was going to come to Gerwin and maybe a bit of a history lesson. If there is something you could point to, and this was a question that came in, another country that you could point to if you think about Asia or even broader economies is China, like Japan, you know, a couple of decades ago? What is the history lesson here that you would look to? And maybe we can leave our audience with that.
>> That is a fantastic question. And I try to not waffle too much. I've seen the mindset of an emerging market investor is not the proper one. [Inaudible]. China is a very large and very historic country. So if you go back 200, 300 years, you always see [inaudible], GDP data back to the birth of Jesus. China was by far the largest economy up until, you know, 2, 3, 200 years ago. And it's obviously much larger than the US. And why is that important? Because having such a long history of relative economic [inaudible]. By the way, Aayush, something similar holds for India as well. It builds institutions. So if you ask any development economist, what is the most important thing a country needs in order to sustain long-term growth and wealth? it's institution, the quality of institutions. They are still there. But what happened in between these periods where you have the decline of the empire, is you had the colonialism, you had world wars, you had the excesses of communism. But then, ever since the Southern Tour of Deng Xiaoping, I mean, China really started coming back to a level it's nowhere near yet. [Inaudible] years ago. So I think the longer-term outlook for China is quite positive. What worries people, though, is the speed of the catch-up. And I think Hongbin and I are not as different on the debt problem. It's a question how you finance it. But the real point is that China actually has, rather than finding something new and novel, it's actually catching up onto something that has been there before. And I think that is something that's overlooked by other investors. But one thing that I did mention, particularly in reference to other Asian economies, is that you know, at a certain point in the development model, there's political change. And you are in Japan, you have the LDP being kicked out, in Korea, you have the military [inaudible] in Taiwan. And the subsequent period saw another lift in per capita income. So that I think is really, really important to look at China as a historical case. And that imparts some, I think, much-needed optimism, actually even for the skeptic or realist.
>> Right. Well --
>> Could I --
>> Go ahead, Hongbin, sorry.
>> [Inaudible] just follow up the Gerwin's comments in terms of catch-up process. Yes, I think the, you know, China actually, you know, what happened in terms of China over the last 40 years, at least in China has follow exactly the footprint of another kind of the, you know, Asia kind of the countries like, you know, typical like Japan, South Korea, Taiwan, Singapore what you call the newly industrialized countries. And I actually, you know, there, the key question here is that, you know, now, you know, where are we in terms of those China's kind of the, you know, catching up process. I think [inaudible] basically misled by focus too much on the size of China's GDP. Everybody's talking about this kind of second-largest economy in the world. But, you know, from the -- purely from a catch-up perspective, what really, in terms of the potential, you know, kind of the growth potential, or potential for any kind of late comer economy to catch up the, you know, the developed world. What really matters is basically the taste trends [phonetic] in terms your productivity of those can lead commerce concur with the level of productivity in the technology from key countries, yeah? And then from that perspective what the best proxy for the technology for productivity level for any country is, A, is basically per capita GDP. If you front [phonetic] look at the per capita GDP perspective, China currently is basically just over 10,000 US dollar, yeah? This is a -- this is a -- this is amazing. This is a great achievement for China over the last 40 years by still, you know, relatively US is still less than 20% of the US in the dollar term. And so in terms of the relative days, kind of in terms of catch-up stage of development catch up, today is China. It's not similar to Japan back to 1990s. This is possibly, [phonetic] this is a very big misconceptions in America. Instead, if you have to compare China with Japan, today's China, in terms of stage of development, is similar to Japan in the early seventies is similar to South Korea in the basically mid-eighties.
>> If you basically might recall, you know, what has happened in the 1980s in Japan and '70s in Japan and what happened in South Korea. And the government doesn't mention that institutions are important. But don't forget that for, even for Korea, which is one of the few very successful kind of the, you know, economists had managed to basically to cross this so-called middle-income trap to [inaudible] into this higher income kind of statutes. [phonetic] During the kind of economical takeoff period, they don't have someone kind of similar kind of Western star, [phonetic] kind of the, you know, political system. It is only after that they have this [inaudible] system. Same, exactly the same piton [phonetic] for, you know, for Taiwan as well. So I will say yes. Yeah, if you're looking from a historical perspective, it does give you a bit of -- put the incident right context. Is really give you a sense in terms of what lie ahead for China, at least in the next kind of [inaudible] kind of the eight to 10 years. In other words, China still hasn't really exhausted its kind of the rooms for them to maintain kind of the catching up kind of piece of the growth.
>> A perfect way to end the conversation is that perspective. But I want to thank all of you for joining and thanks to the panel. A special thanks to Hongbin and May for joining in Asia. I know it's late there. But for more information on our China Investment Symposium Series, please visit www.PGIM.com/CIS. You'll see replays of past events, including a replay of this event. And on behalf of all my colleagues at PGIM, want to wish everybody a happy New Year and best wishes. Take care.
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