Speaker 1: Welcome to Kobe Time, a podcast series on Markets and
Speaker 1: Economies from Devis Group Research. I'm BA chief economist. Welcoming
Speaker 1: you to our 104th episode today. It's all about China.
Speaker 1: While in the US, you have this whole story of
Speaker 1: resilient economic growth and still sticky inflation, which has combined
Speaker 1: to create this narrative of interest rates going higher for longer.
Speaker 1: The opposite is the case in China. Uh post pandemic
Speaker 1: rebound has been underwhelming. Financial markets are listless and prove
Speaker 1: that inflation momentum is muted
Speaker 1: what to make of China's near and medium term outlook
Speaker 1: in the context of all that. Well, we have a
Speaker 1: seasoned expert with us to talk about all this.
Speaker 1: Santiago Milan is a member of Wellington Management's Global Macro
Speaker 1: strategy group. Wellington is one of the world's largest asset
Speaker 1: managers with over a trillion dollars of client assets under management.
Speaker 1: Santiago leads their efforts in thematic analysis and sector based
Speaker 1: macro research for China and other Asian countries. He's an
Speaker 1: active participant in investment strategy groups focusing on both debt
Speaker 1: and equity markets. Santiago Milan, welcome to COVID
Speaker 2: Time.
Speaker 2: Thank you. It's my pleasure to be here. Uh
Speaker 1: So good to talk to you, Santiago, you and I
Speaker 1: met almost 15 years ago and uh we have met
Speaker 1: in multiple places in Asia. I was just thinking, I
Speaker 1: think we were on a trip to the Philippines once
Speaker 1: I met you in Hong Kong many times. Great to
Speaker 1: have you on the podcast.
Speaker 2: Thank you. Yeah. No, it's great to see you. And
Speaker 2: it's been quite an adventure over the years.
Speaker 1: Indeed. You are talking to me from Boston, but that
Speaker 1: has not been your address the past decade and a half.
Speaker 1: So reflect on what you have been doing the past
Speaker 1: decade and a half.
Speaker 2: Sure, so well, it's been definitely an interesting decade. I
Speaker 2: would say that I've been observing uh from almost a
Speaker 2: front row seat, all of these changes and development that
Speaker 2: has been happening in China and in Asia more broadly.
Speaker 2: And China has changed a lot in 15 years when
Speaker 2: I arrived in Hong Kong,
Speaker 2: China was at the tail end of a spectacular boom
Speaker 2: in the economy that had begun with China's accession to
Speaker 2: the WTO and uh lots of reform and opening the
Speaker 2: economy was booming, asset prices were booming everything the stock
Speaker 2: market had more than tripled in three years. And the
Speaker 2: world's leaders all came to Beijing
Speaker 2: for the 2008 Olympics, that vibe was one of pervasive optimism.
Speaker 2: And this carried through even through some of the doubts
Speaker 2: of the global financial crisis. And indeed China did uh
Speaker 2: do a lot of the heavy lifting to get the
Speaker 2: world out of the GFC.
Speaker 2: The economy actually did deliver since then when I arrived
Speaker 2: in Hong Kong. Uh China's GDP was $3.5 trillion. It
Speaker 2: was the fourth or fifth largest economy in the world.
Speaker 2: Since then, China's GDP has grown fivefold. It's now $17
Speaker 2: trillion plus. Um
Speaker 2: and China was supposed to grow a lot, it did
Speaker 2: grow a lot, however, not everything was as expected. In particular,
Speaker 2: one would expect with this type of, of performance that
Speaker 2: I just described that. Well, asset prices would have done
Speaker 2: fantastic and guess what they didn't
Speaker 2: in part for, for uh structural reasons. But also because
Speaker 2: of uh this fact that I mentioned, which was that
Speaker 2: the asset prices were in a huge bubble in 2007,
Speaker 2: early 2008, the stock market in those 15 years has
Speaker 2: actually been flat or slightly up or down depending on
Speaker 2: how you measure it.
Speaker 2: Hs CE I which is the index of China mainland
Speaker 2: listed companies in Hong Kong is actually down almost 40%.
Speaker 2: From the day I arrived in Hong Kong to the
Speaker 2: day I left in Hong Kong. So economy grew by
Speaker 2: five times stock market did nothing qualitative changes, however, have
Speaker 2: been huge and I think they're even bigger than the
Speaker 2: uh quantity
Speaker 2: changes. What are these qualitative changes? Well, first, the infrastructure
Speaker 2: stock has uh flourished in an unbelievable way when I
Speaker 2: got to Hong Kong. Um The the first uh high
Speaker 2: speed rail line was just being inaugurated from Beijing to Tianjin.
Speaker 2: I remember I wrote it and it was really exciting now,
Speaker 2: uh the country has by far the largest high speed
Speaker 2: rail network
Speaker 2: in the world. Uh 50 or so, Chinese cities have
Speaker 2: subway systems and this connectivity infrastructure is massive and it
Speaker 2: has all been developed in the last 15 years. Education
Speaker 2: has also changed dramatically. When I uh got to Hong Kong,
Speaker 2: there were around 2 million um graduates uh from higher
Speaker 2: education every year. This year, it will be 11 million.
Speaker 2: And finally, I'll mention one thing among many others that
Speaker 2: have changed dramatically, the development of the service economy. And
Speaker 2: I remember when I got uh to to Hong Kong
Speaker 2: and and started uh having discussions about what was the
Speaker 2: future of the Chinese economy.
Speaker 2: There were many, many doubts about whether China would or
Speaker 2: could develop a uh really serious and successful service economy
Speaker 2: and indeed it has it's already there, there are challenges
Speaker 2: and we can talk about them. But those are my
Speaker 2: observations in the rear view mirror time to look forward.
Speaker 1: Indeed, uh Santiago, I do wanna talk about some of
Speaker 1: the structural challenges with you in the latter part of
Speaker 1: this podcast, but let's stay with the near term for
Speaker 1: the time being. So what's your sense of China and
Speaker 1: macro at this point? So economic momentum for the second
Speaker 1: half of this year uh underwhelming worrisome. Where, where do
Speaker 1: you stand?
Speaker 2: Yeah, absolutely. I think that um um it, it's, it's
Speaker 2: very difficult to really calibrate uh a, a message that
Speaker 2: uh targets an audience uh accurately. And the reason is
Speaker 2: that the spectrum of beliefs about the Chinese economy is very,
Speaker 2: very wide. But I agree with uh I think what
Speaker 2: you um suggested, which is that there is a lot
Speaker 2: of pervasive pessimism.
Speaker 2: Um I think that pessimism is uh has a, a
Speaker 2: grain of truth. Uh But I wouldn't really go overboard
Speaker 2: with uh a narrative that suggests that China will collapse
Speaker 2: or that China will face
Speaker 2: a Japan like scenario in the future. Most importantly, because
Speaker 2: China is still not a developed economy. Um But one
Speaker 2: thing to keep in mind is that the policy and
Speaker 2: institutional objectives of the Chinese government have changed significantly and
Speaker 2: this goes to a burning question and a frustration I
Speaker 2: would say for the analy
Speaker 2: community and the investment community and some of the business community,
Speaker 2: which is, you know, why aren't the policy makers as
Speaker 2: worried as we are? Uh We read headlines about a
Speaker 2: youth unemployment rate above 20%. Um We uh see the,
Speaker 2: the the economic activity indicators come in uh worse than
Speaker 2: expected uh month after month, what's going on? Why aren't
Speaker 2: they worried?
Speaker 2: And I think there are two answers there. The first
Speaker 2: one is that the uh authorities actually frankly uh don't
Speaker 2: see the type of negativity that the markets see they
Speaker 2: are very focused on the medium term and in the
Speaker 2: medium term, uh they feel that uh that, that, that
Speaker 2: there needs to be a lot of patience and uh they,
Speaker 2: they are uncomfortable with the type of breakneck uh uh
Speaker 2: infrastructure driven growth that was there in the past, the
Speaker 2: one that I mentioned, for example, that allowed China to
Speaker 2: do a lot of the heavy lifting for the world
Speaker 2: to get out of the global financial crisis.
Speaker 2: And uh you know, and I know that you wanted
Speaker 2: to stick to the short term, but I'll mention one
Speaker 2: long term issue because I think it is very relevant
Speaker 2: to the short term. And that is that I think
Speaker 2: China
Speaker 2: is right now in the process of uh shifting uh
Speaker 2: or making its third big shift or big change in
Speaker 2: the policy stance in the institutional priorities of uh the
Speaker 2: uh of uh of, of, of the government and of development.
Speaker 2: And uh what, what is the third? Well, the first
Speaker 2: one was essentially the revolution itself, the establishment of communism
Speaker 2: from the revolution in 1949. All the way until reform
Speaker 2: and opening all of the economic activity in China was
Speaker 2: politically developed, determined
Speaker 2: that led China to a situation in the seventies where
Speaker 2: its GDP per capita was lower than sub-saharan Africa. Its
Speaker 2: um uh industrial share of the economy was lower than
Speaker 2: North Korea and it was very clear that the uh
Speaker 2: some of the development objectives of uh the the policymakers
Speaker 2: were not going to be met. And this led to
Speaker 2: the second big period of uh or institutional framework
Speaker 2: which was reform and opening. And we know what that
Speaker 2: was all about. It was about letting market forces enter
Speaker 2: the economy and unleash massive amounts of economic activity. It
Speaker 2: worked very well in achieving development itself and growth itself.
Speaker 2: But around 10 years ago, again, China found itself with
Speaker 2: a bunch of externalities to that model that its policymakers
Speaker 2: didn't particularly like. Um
Speaker 2: And what are those externalities? They are massive uh uh
Speaker 2: environmental damage. They are a big, big inequality by some measures.
Speaker 2: Uh Chinese income inequality and also wealth inequality are even
Speaker 2: bigger than the United States. Uh And also uh one
Speaker 2: other externality was uh that the uh open markets and
Speaker 2: uh access to uh uh uh these types of opportunities
Speaker 2: created pockets of wealth that combined with pockets of power
Speaker 2: that uh created a degree of political uh uncomfortableness that
Speaker 2: the the that the leadership was not happy with. And
Speaker 2: so now we are in the third big era of
Speaker 2: uh in
Speaker 2: institutions, policy making and governance. And let's call it the
Speaker 2: era of common prosperity for lack of a better word.
Speaker 2: And we don't really know what this era really means
Speaker 2: just like in the beginning of reform and opening, we
Speaker 2: didn't know what it would be like, right. Now we
Speaker 2: are crossing the river by feeling the stones if you
Speaker 2: will
Speaker 2: to determine what uh the new era of common prosperity means.
Speaker 2: But one thing we know for sure, the um emphasis
Speaker 2: on growth uh at any cost and the emphasis on
Speaker 2: material advancement is not there. And that answers a lot
Speaker 2: of this frustrating question. Why aren't the policymakers as worried
Speaker 2: as the market?
Speaker 1: Fascinating uh you know, characterization Santiago would I would assume
Speaker 1: that that lack of clarity runs beyond the analyst community
Speaker 1: and spills over into the day to day Chinese population.
Speaker 1: Uh And would you say that uh sort of, you know,
Speaker 1: frustration or lack of clarity as to where things are
Speaker 1: going is one of the reasons why we haven't seen
Speaker 1: a big post pandemic bump uh because that, that uncertainty
Speaker 1: clouds people's animals, ferrets and exuberance and therefore, yeah, I
Speaker 1: can go out now, but I don't think I'm going
Speaker 1: to spend a lot of money or plan for a major,
Speaker 1: you know, expansion of my company.
Speaker 2: Absolutely. I think that's a, that's, that's very much right. Obviously, the,
Speaker 2: the the whole picture is a mosaic that is complex
Speaker 2: and includes more than just this. But this ingredient I
Speaker 2: think is very, very important. Um You see that the
Speaker 2: uh on, on this uh area, the government is not
Speaker 2: exactly standing still.
Speaker 2: Uh Yes, there are changes and those changes create uncertainty,
Speaker 2: but you do see parts of the leadership, for example,
Speaker 2: the Premier Li Chang um frequently uh approaching the private
Speaker 2: sector and uh other uh constituents in the economy, trying
Speaker 2: to reassure them that the role of
Speaker 2: the private sector will still be uh well. Uh the
Speaker 2: the the almost the core of the Chinese uh development,
Speaker 2: producing the bulk of the employment, producing the bulk of
Speaker 2: the consumption and therefore the bulk of the momentum for
Speaker 2: the uh Chinese economy. With that said
Speaker 2: um II I, you know, back to your point on,
Speaker 2: on the issue of confidence, it's important to remember that
Speaker 2: the three years of COVID and GEOPOLITICAL conflict and also
Speaker 2: political transition were quite traumatic uh for the Chinese consumer
Speaker 2: and business environment much more. So I would say than
Speaker 2: for the rest of the world, this is not just
Speaker 2: about the lockdowns, this is also about some of these
Speaker 2: signals about changes in institutions. I would say one big
Speaker 2: one that the markets of course were very much affected
Speaker 2: by uh was the regulation uh of the uh uh
Speaker 2: uh uh I would say of uh certain areas of
Speaker 2: private services including
Speaker 2: uh platform uh internet companies. And of course, uh the
Speaker 2: uh private education sector and those two things among others
Speaker 2: uh got people very, very nervous about the overall direction
Speaker 2: of the Chinese economy. And now we are again, I
Speaker 2: would say in this process of discovery
Speaker 2: of what the true environment is like. My assessment of
Speaker 2: this is that the true environment is definitely not as
Speaker 2: it was in the era of reform and opening. So
Speaker 2: it certainly is different but it probably is not as
Speaker 2: negative as some of the more negative narratives that there
Speaker 2: are out there and probably not as negative or
Speaker 2: very likely not as negative as what some of the
Speaker 2: more depressed areas of the Chinese stock market are suggesting
Speaker 2: in particular, I would point to these Hong Kong listed
Speaker 2: Chinese stocks that are owned mostly by international investors which
Speaker 2: are trading at some of the lowest valuations depending on
Speaker 2: how you measure it in 20 years, sometimes more than
Speaker 2: 20 years,
Speaker 1: right? So what does that mean for the financial markets
Speaker 1: in the near term do is is a valuation attractive
Speaker 1: because it's low or the valuation is not attractive because
Speaker 1: the low evaluation is telling us something
Speaker 2: you have to ask a difficult question, didn't you? Uh
Speaker 2: Yeah, I think, I think um uh well, you know,
Speaker 2: the first thing I would say is that if you
Speaker 2: look at equities, um uh there is a very, very
Speaker 2: big uh segmentation in the market offshore and onshore. Uh
Speaker 2: My view is that the offshore equities are simply too
Speaker 2: cheap even if we factor in uh uh the the
Speaker 2: the fact that the the the developments are actually concerning.
Speaker 2: Um I uh frequently describe uh the valuation for these
Speaker 2: stocks as the inverse of a bubble. Why is that
Speaker 2: a useful concept? Well, a bubble on the upside typically
Speaker 2: forms because the market recognizes a fundamental,
Speaker 2: mentally structurally positive aspect of a market or an industry.
Speaker 2: The internet today, what we're doing today actually, right now
Speaker 2: in this conversation is probably 20 times better than what
Speaker 2: anyone imagined in the year 2000. And yet it was
Speaker 2: time to sell stocks.
Speaker 2: Um back to the China example, I think the market
Speaker 2: did recognize that there are some reasons for concern. As
Speaker 2: I said there, this is a big change in institutions.
Speaker 2: This is a big change in the policy stance, lots
Speaker 2: of uncertainty is involved. But the way that these stocks
Speaker 2: are trading
Speaker 2: at uh you know, single digit uh trend pe s
Speaker 2: and valuations that are lower than they have been in
Speaker 2: a multiple decades suggests to me that this is overdone
Speaker 2: and that uh there is upside in uh the offshore stocks,
Speaker 2: the onshore stocks are much more complicated on the surface.
Speaker 2: They look in my view basically fairly valued.
Speaker 2: But the problem is that once you open up the
Speaker 2: hood and you see uh you, you have a look
Speaker 2: at the stocks that uh investors actually like that bottom
Speaker 2: up analysts uh find quality in, you find that lots
Speaker 2: of these stocks are actually again in a segmented market
Speaker 2: trading at very very high valuations. And so it is
Speaker 2: a very difficult job to be a China stock picker,
Speaker 1: right? I mean, like just this year, I mean, we've
Speaker 1: seen China bank stocks and telecom stocks rally uh something
Speaker 1: that they haven't done in a very long time. And
Speaker 1: the darlings of recent years, the tech stocks in particular
Speaker 1: have done absolutely nothing. Uh onshore or offshore. Um Santiago earlier,
Speaker 1: you were talking about authorities have begun to make overtures
Speaker 1: to market participants saying that, you know, the
Speaker 1: tumult of recent years, you know, it's behind us, things
Speaker 1: are gonna be constructive, private sector has an important role.
Speaker 1: So go out innovate, invest, we're, we're behind you. So
Speaker 1: let's talk about the whole regulatory backlash of the last
Speaker 1: couple of years. And is it indeed your sense that
Speaker 1: it is where
Speaker 1: reflection point that they are not gonna be as much
Speaker 1: backlash going forward? Um I sort of think you sort
Speaker 1: of touched upon the services sector, particularly education tach for me, gaming,
Speaker 1: crypto other things come to mind and of course, general
Speaker 1: data privacy issue a around which, you know, some tech
Speaker 1: companies have been uh really, really, you know, uh hurt by,
Speaker 1: by the uh regulatory uh out. Uh I was gonna
Speaker 1: say overreach, but rather regulatory action.
Speaker 1: So where are we with respect to the whole regulatory framework?
Speaker 2: Hm.
Speaker 2: Yeah. No, that's a great question. Um My view uh
Speaker 2: you know, as, as, as, as typical is that, you know,
Speaker 2: it's a, it's a, it's a mixed bag. I I
Speaker 2: would say that um the, the, the place I would
Speaker 2: start is that the regulation of these sectors was inevitable
Speaker 2: and it's not in just inevitable in China, it's inevitable
Speaker 2: pretty much everywhere else in the world.
Speaker 2: A lot of the regulatory steps that really got the
Speaker 2: market spooked were very similar types of data regulation and
Speaker 2: anti monopoly regulation. Uh That for example, Europe has now
Speaker 2: with that said, the elephant in the room is that
Speaker 2: Europe has no world class internet companies and it is
Speaker 2: probably no coincidence that they have strong regulation and no
Speaker 2: world class internet companies.
Speaker 2: The strong regulation in China, I think is unlikely to
Speaker 2: eliminate the internet companies altogether as it did in Europe
Speaker 2: or the big ones at least because uh China is
Speaker 2: essentially a protected market and it is very difficult for
Speaker 2: foreigners to compete in that market because of the obvious reasons.
Speaker 2: Um
Speaker 2: But uh nevertheless, uh you know, it's, it's, it's important
Speaker 2: to uh to realize that these regulations are there and
Speaker 2: it's not, they're not going to go away with that
Speaker 2: said um within the bird cage if, if you will
Speaker 2: of these regulations,
Speaker 2: uh there is uh no reason why these companies cannot
Speaker 2: continue to grow and to grow a lot. It's going
Speaker 2: to be a more competitive landscape than it is in
Speaker 2: other places. Valuations definitely need to adjust for these, for
Speaker 2: this new reality, but they have already a adjusted.
Speaker 2: And the last thing that I would say is that
Speaker 2: the government seems to be kind of of two minds
Speaker 2: about the service sector and service driven GDP growth. On
Speaker 2: the one hand, uh lots of the leadership recognizes that
Speaker 2: the service sector is essentially the engine of job creation
Speaker 2: in China. In fact, manufacturing employment in China peaked around
Speaker 2: a decade ago, has been coming down ever since.
Speaker 2: Uh manufacturing output continues to rise because of automation and
Speaker 2: other things. Um And uh you know, this role uh
Speaker 2: as an employment creator is very uh important and valued
Speaker 2: by the, the leadership. And they are uh are very unlikely,
Speaker 2: I would say to kill this goose that lays golden
Speaker 2: eggs in that sense.
Speaker 2: And the last thing that I would say is that
Speaker 2: there's also a recognition by the leadership that the service sector.
Speaker 2: And I would say this interconnected digital uh service uh sector,
Speaker 2: the world of platform,
Speaker 2: platform economies and so on virtual worlds. Um uh It
Speaker 2: is very, very important to essentially uh do something very
Speaker 2: basic but critical for economic development, which is to enlarge
Speaker 2: the market.
Speaker 2: The market is much, much bigger when uh there is
Speaker 2: so much connectivity when uh each individual supplier has access
Speaker 2: to not just a handful of customers around their neighborhood,
Speaker 2: but to a huge national market. And uh therefore, uh
Speaker 2: the the the the the service sector in general and
Speaker 2: digital interconnected services in particular are something that uh is
Speaker 2: unlikely to be crushed by the government. The heavy lifting
Speaker 2: of the regulation in my view is already done.
Speaker 1: So, speaking of digital services uh that this year is
Speaker 1: all about large language models. And A I and we
Speaker 1: have seen amazing run up in still a group of
Speaker 1: stocks in the US around that narrative seem to be
Speaker 1: missing that in the context of China. Although like if
Speaker 1: I follow South China Morning Post, there are
Speaker 1: stories that are coming out about how companies from Alibaba
Speaker 1: or Baidu are sort of bringing in various layers of
Speaker 1: A I capability. The authorities are engaging the private sector
Speaker 1: and setting up some degree of thinking and uniform standards
Speaker 1: about A I. Um but somehow or the other, it's
Speaker 1: not really catching the global investors interest.
Speaker 2: Yeah, I think that's uh that's interesting. I mean, to
Speaker 2: your point, uh uh there are places where it is
Speaker 2: catching in interest and in particular in the shares when
Speaker 2: you look at certain comp companies that are geared towards this,
Speaker 2: some of which you mentioned, um uh they, they have
Speaker 2: performed quite well. Uh But uh but I, I definitely
Speaker 2: agree that overall there isn't that sense of hype?
Speaker 2: Um I, I would say that uh that, that, that
Speaker 2: a lack of hype uh does not mean that there
Speaker 2: is an absence of uh the A I uh development
Speaker 2: in China. I think it's important to remember that the
Speaker 2: IP for A I
Speaker 2: uh is uh very much uh uh well, well, China is,
Speaker 2: is a, a very, very uh important player in generating
Speaker 2: the IP. If you look at, for example, the proportion
Speaker 2: of cited peer reviewed papers uh in the top 1%.
Speaker 2: Um China is uh I I think number one or
Speaker 2: close to number one.
Speaker 2: And if you look at, as you said, uh the
Speaker 2: development of the A I, uh there are multiple companies
Speaker 2: that are doing this.
Speaker 2: Um One thing to keep in mind is that China
Speaker 2: as it was with other digital services is going to
Speaker 2: take a much more conservative attitude towards the regulation of this.
Speaker 2: And perhaps a lot of what is uh keeping uh
Speaker 2: the well the overall participants and the investors from reaching
Speaker 2: a stage of euphoria is the uncertainty about
Speaker 2: what that regulation means. I understand that. And as you
Speaker 2: might guess, you know, my opinion lands somewhere in the middle,
Speaker 2: I don't think that a hype around A I in
Speaker 2: China is merited because there is uncertainty. But I also
Speaker 2: hear a lot of pessimism that China will fall far
Speaker 2: behind the rest of the world in A I because
Speaker 2: of some of these issues and also because of the
Speaker 2: geopolitical issues having to do with semiconductors. And my view
Speaker 2: is that um uh in, in the medium term, uh
Speaker 2: China will continue to be at the forefront of these developments.
Speaker 2: Uh and we will see uh huge amounts of applications
Speaker 2: of A I.
Speaker 2: Uh One last thing um is that uh A I
Speaker 2: in China is also uh much more present than in
Speaker 2: other parts of the world in things like city management,
Speaker 2: smart cities. Uh And uh this is probably under recognized
Speaker 2: uh how much efficiency uh gains there are from this,
Speaker 2: in particular, in a world that tends to look at
Speaker 2: these headlines through the uh dark, darker side of the
Speaker 2: narrative which uh relates to control of the population and
Speaker 2: so on.
Speaker 1: Santiago, not now, but rather six years ago, I was
Speaker 1: using Ride hailing apps in Shanghai and they had simultaneous translation.
Speaker 1: Uh And uh I was sort of, you know, reading
Speaker 1: about the way uh the
Speaker 1: supply of ride hailing cars were managed through their A
Speaker 1: I framework uh calibrating toward, you know, rush hour versus not,
Speaker 1: I mean, these things, they have been all hats at
Speaker 1: it for a while. Um So I fully agree with
Speaker 1: you that uh the, the layers of application, it's not
Speaker 1: like something that began or ending with Chad GP T
Speaker 1: they've been at it for a while.
Speaker 2: Yeah, that's right. Uh you know, image recognition is a
Speaker 2: huge part of A I. And uh you know, China
Speaker 2: was there from the beginning. Uh their uh companies uh and,
Speaker 2: and their institutes were um you know, at the, at
Speaker 2: the forefront of uh their competitions in image recognition, for example,
Speaker 2: which was uh you know, one of the first big
Speaker 2: steps in the development of A I and now I, I'll,
Speaker 2: I'll give you an example
Speaker 2: um of something that I saw recently. Uh in, in China,
Speaker 2: which was um a, a uh, a service that allows
Speaker 2: for companies that uh do the maintenance and the checking
Speaker 2: of uh power lines
Speaker 2: uh to do this without people. It used to be
Speaker 2: that you had to have armies of thousands of people
Speaker 2: that would physically climb each utility pole and check to
Speaker 2: make sure everything is. All right
Speaker 2: now with uh computer vision and image recognition and artificial intelligence.
Speaker 2: This is done in a period of three days using
Speaker 2: three people that manage drones uh remotely. Uh whereas it
Speaker 2: used to take thousands of people uh more than a
Speaker 2: month to do it in the past. So these are
Speaker 2: the types of things that can happen with the development
Speaker 2: of A I
Speaker 1: um Santiago earlier at the very beginning of this conversation,
Speaker 1: when we were talking about you coming to Hong Kong
Speaker 1: 15 years ago and you mentioned that China played a
Speaker 1: very important counter cital role at that time with very
Speaker 1: large stimulus measures just as the world economy was struggling
Speaker 1: under the global financial crisis. But of course, the legacy
Speaker 1: of that big stimulus was uh you know, mother of
Speaker 1: all debt formation
Speaker 1: and that trend has just progressively gotten worse over the
Speaker 1: past decade and a half. So let's talk a little
Speaker 1: bit about China's debt overhang. Um Looking at other countries,
Speaker 1: you used to work on Latin American countries, you've looked
Speaker 1: at other examples around the EM and DM space. What
Speaker 1: are the lessons from other countries with debt management that
Speaker 1: China can sort of embrace to, to deal with this,
Speaker 1: this debilitating problem.
Speaker 2: Yeah. Yeah. No, that, that, that's a very uh good question.
Speaker 2: And it also begs the question, you know, is China
Speaker 2: different uh because of its size because of uh it, its,
Speaker 2: its policy. I would say there are two big lessons
Speaker 2: from other countries. The first one is, don't rely on
Speaker 2: the kindness of strangers to fund your financing gaps. And
Speaker 2: the second one
Speaker 2: is to ensure that you can coordinate the uh players
Speaker 2: uh that are engaged in the distribution of the uh
Speaker 2: of of the debt if it has to be uh restructured.
Speaker 2: Uh China has those two factors. It, its debt is
Speaker 2: owned uh almost entirely domestically, very, very little exposure to
Speaker 2: uh foreign funding. Uh and China is an excess saver
Speaker 2: rather than an importer of savings. And that could be
Speaker 2: problematic in other areas, but it's definitely not a problematic when, when,
Speaker 2: when we think about it in terms of the debt angle.
Speaker 2: Um
Speaker 2: and um uh and, and, and I, I would, I
Speaker 2: would say maybe I'll, I'll finish here. Um China definitely
Speaker 2: does have uh the these uh these factors that uh are,
Speaker 2: are lessons learned from other places, but that doesn't mean
Speaker 2: that the debt isn't a problem,
Speaker 1: right? So I um normally, you know, this is my
Speaker 1: old IMF training that, you know, the the debt dynamic equation,
Speaker 1: which is a function of, you know, your real interest
Speaker 1: rate and real GDP growth rate. If you through financial repression,
Speaker 1: for example, keep interest rates very, very low. So it
Speaker 1: sort of turned negative in real terms, you can afford
Speaker 1: a lot of debt. And I think China by virtue
Speaker 1: of having a somewhat of a closed capital account can
Speaker 1: have monetary policy that is, you know,
Speaker 1: attuned to financial repression while the rest of the world
Speaker 1: is struggling with high interest rates and high inflation. Um
Speaker 1: But the, the bad thing out of all that is,
Speaker 1: of course, you know, you then end up having zombie
Speaker 1: companies like Japan or you stay with a slow burn
Speaker 1: uh as opposed to, you know, recognizing issues quickly uh clearly,
Speaker 1: those authorities don't have an appetite to remove the band aid, right?
Speaker 1: It would be a slow
Speaker 2: burn.
Speaker 2: Um Yes. Uh I, I would say that the, the
Speaker 2: general answer to your question is uh yes. Uh I now,
Speaker 2: 11 thing though uh about the near term and uh
Speaker 2: uh you know, well, actually the present is that there
Speaker 2: is a recognition that perhaps
Speaker 2: perhaps given some of the factors that you are talking about,
Speaker 2: which is a relatively stable environment that is uh facilitated
Speaker 2: by financial repression uh that there could be steps taken
Speaker 2: to uh tackle at least the local government. Uh and LGFB, local,
Speaker 2: local government, financial vehicle and provincial debt uh situation.
Speaker 2: Um That is a possibility in the near term. Uh
Speaker 2: It will be complex and full of uncertainty because the
Speaker 2: government needs to take action while reducing the risk of
Speaker 2: moral hazard. It needs to restructure things and promise that
Speaker 2: uh you know, they will never be restructured again. Um
Speaker 2: uh This will not be a quick or simple process.
Speaker 2: It probably begins with uh centralized audit of all of
Speaker 2: the provinces and all of the debt. Uh and to
Speaker 2: figure out how to match the liabilities with
Speaker 2: assets to figure out what is the solvency of these provinces.
Speaker 2: And they probably know that already. But the reason why
Speaker 2: an audit would be necessary in the beginning is to
Speaker 2: make it all common information so that everybody knows how
Speaker 2: everybody else is doing
Speaker 2: from there. Uh figure out what uh a portion of
Speaker 2: the debt problem can be resolved by simply uh matching
Speaker 2: assets with liabilities and selling assets to CRE to free
Speaker 2: up um uh cash flows and so on.
Speaker 2: And then, um uh you know, after that, uh having
Speaker 2: the diff more difficult steps of actually restructuring some of
Speaker 2: these debts and figuring out where the financing is going
Speaker 2: to be, where the funding is going to be uh
Speaker 2: to do this. Um Despite that, uh however, I would
Speaker 2: say that the big picture remains that uh Chinese growth
Speaker 2: and this is
Speaker 2: somewhat unique to China. But there are a lot of
Speaker 2: Asian countries that share this future is very much debt
Speaker 2: driven and those issues that you mentioned are very real,
Speaker 2: not just zombie companies uh that essentially live beyond their
Speaker 2: useful purpose, but also from an equity investor perspective. It's
Speaker 2: very important to remember that over the medium term, excessive
Speaker 2: reliance on debt will eat into the cash flows to equity.
Speaker 2: And that I think is one of the reasons for
Speaker 2: this lackluster long term economic uh market performance that I
Speaker 2: discussed earlier.
Speaker 1: Very, very interesting. Um
Speaker 1: Let's talk a little bit more in the context of
Speaker 1: China's consolidated balance sheet if you will. So the country
Speaker 1: has large debt domestically well known. And to your point,
Speaker 1: there are ways to address it, nothing simple but can
Speaker 1: be addressed um with some degree of sort of, you know,
Speaker 1: brave policy making. Uh but we talk separately but we
Speaker 1: don't combine it with the other issue which is that
Speaker 1: China is a very large creditor internationally.
Speaker 1: So net net, does it all work out to China's favor?
Speaker 2: Yeah. Yeah, that's a, that's, that's another great question. Um
Speaker 2: I would say net net, it's, it's uh it's very
Speaker 2: difficult to, to really think about anybody's favor. Um The
Speaker 2: fact that there are uh large uh foreign assets I
Speaker 2: think is very important in the sense that uh as
Speaker 2: well as you very well know from uh the, the
Speaker 2: the
Speaker 2: story of what drives financial instability and what drives financial crisis.
Speaker 2: There is almost always a big, big link between international
Speaker 2: pressure on the currency and assets and uh domestic financial instability.
Speaker 2: And so China is actually similar to Japan in this sense,
Speaker 2: in the sense that
Speaker 2: uh uh investors might be looking at a huge, huge
Speaker 2: stock of liabilities, but they also are looking at a huge,
Speaker 2: huge stock of future foreign exchange to match those liabilities.
Speaker 2: And that makes it much more difficult for a run
Speaker 2: on the currency to become a trigger for massive financial
Speaker 2: instability. And this is true both in terms of the stock. Therefore,
Speaker 2: you know, the the the the assets themselves and also
Speaker 2: the flow China continues to be a net saver with
Speaker 2: a significant current account surplus in absolute terms, even if
Speaker 2: it's not as big as it used to be relative
Speaker 2: to GDP.
Speaker 2: So I would say that this uh external credit or
Speaker 2: status of China is something that is definitely significant and
Speaker 2: important doesn't get us all the way out of the woods,
Speaker 2: but it does signify a much more stable uh likely
Speaker 2: dynamics uh than uh if it were the case that
Speaker 2: China did not have this
Speaker 1: right. So the country is a major creditor nation has
Speaker 1: large stocks of reserves. And I've been reading certain threads
Speaker 1: in and on Twitter lately about how there could be
Speaker 1: almost equal amount of sort of missing reserves or unreported
Speaker 1: reserves on the balance sheet of multilateral uh agencies uh
Speaker 1: run by the Chinese authorities. Um But at the same time,
Speaker 1: we do have
Speaker 1: quite a few large Chinese corporations who have issued substantial
Speaker 1: amount of foreign currency debt in recent years and decades.
Speaker 1: And they have huge wall of financing coming up. And
Speaker 1: this is happening at a time when international interest rates
Speaker 1: have gone up a lot dollar liquidity, although
Speaker 1: not as tight as we would have feared a year
Speaker 1: ago because of QT and higher interest rates, but still
Speaker 1: not as ample as they used to be and going
Speaker 1: forward would get tighter. Um So us monetary policy tightening,
Speaker 1: it will have an impact on Chinese companies who want
Speaker 1: to refinance their debt.
Speaker 2: Absolutely. And um you know what I would say is
Speaker 2: that the offshore corporate or the dollar corporate uh market
Speaker 2: for Chinese companies is very, very distorted. And so I
Speaker 2: it definitely affects the overall macro, it definitely affects these
Speaker 2: companies in a negative way.
Speaker 2: But again, I wouldn't really be uh uh quick to
Speaker 2: say that this will be a source of massive overall
Speaker 2: macro instability. A few things are worth noting about that
Speaker 2: offshore uh dollar denominated corporate market. The first one
Speaker 2: is that it is almost entirely dominated by real estate firms.
Speaker 2: And that is peculiar if we think about it because
Speaker 2: real estate firms are not natural borrowers in international markets
Speaker 2: because they don't have revenue in US dollars. So this
Speaker 2: actually adds uh you know, to the, to, to, to
Speaker 2: the concerns that you meant
Speaker 2: that you mentioned uh in particular, if we think about
Speaker 2: the fact that Renminbi is now depreciating as well as
Speaker 2: uh having higher us interest rates. So why are the
Speaker 2: these real estate developers out there in the uh dollar
Speaker 2: corporate market? Well, the reason has to do with some
Speaker 2: of the repression issues that you mentioned earlier,
Speaker 2: uh the Chinese government as part of its policy uh
Speaker 2: has been trying to uh move away from what it
Speaker 2: sees as a dependence on real estate development for its
Speaker 2: economic growth. And therefore, has made it very difficult historically
Speaker 2: for these firms to borrow in the onshore market. And
Speaker 2: their solution to that problem has in many cases been
Speaker 2: to go uh abroad.
Speaker 2: Um So the the there there is that issue there.
Speaker 2: And then finally, I think to complete the picture, we
Speaker 2: need an idea of whether this problem which is a
Speaker 2: real problem. I I agree. Uh III I is is
Speaker 2: big enough to,
Speaker 2: to make us concerned about systemic instability. And there I
Speaker 2: would say the answer is that it is unlikely because
Speaker 2: even though it is big by global standards, because China
Speaker 2: is huge, it's the second biggest economy in the world
Speaker 2: in nominal terms.
Speaker 2: Um it is very, very small relative to the stock
Speaker 2: of liabilities or the stock of interest payments uh in
Speaker 2: the overall system. And again, it is also very much segmented,
Speaker 2: uh there are capital controls and uh that this point
Speaker 2: that you mentioned earlier about China being a net creditor
Speaker 2: and a net saver is also important when we think
Speaker 2: about these factors. So I wouldn't be too concerned.
Speaker 1: Right. Right. This is not a dollar deficient economy by
Speaker 1: any stretch of imagination. Um, bit of a jump, not
Speaker 1: necessarily related to what we've been talking about, but this
Speaker 1: is something that you and I have spoken about in
Speaker 1: the past and I would really want you to weigh in. Um,
Speaker 1: we talk a lot about China sort of running out
Speaker 1: of engines of growth. Uh But we also recognize
Speaker 1: is that there is one area of structural shift where
Speaker 1: China has massive scope for investment and growth and innovation
Speaker 1: and they're added already, which is climate change. So give
Speaker 1: me a little sense of your assessment on what is
Speaker 1: China doing with respect to climate change?
Speaker 2: That is a great question. Um And I think that
Speaker 2: China is very much misunderstood for good reason, it's very
Speaker 2: difficult to understand China in terms of climate change. On
Speaker 2: the one hand, if you look at a snapshot of China,
Speaker 2: what you see is by far, the world's biggest emitter
Speaker 2: of carbon emitting almost as much more than at the, the,
Speaker 2: the US and Europe put together and you see a
Speaker 2: country where emissions have not yet peaked,
Speaker 2: whereas in most of the developed world, they have already peaked.
Speaker 2: And so there is room uh to ask for more
Speaker 2: from China if you look at that snapshot. But if
Speaker 2: you look underneath the surface again. Or if you look
Speaker 2: at the other side, China is also the world's biggest
Speaker 2: investor
Speaker 2: uh in renewable technologies and in uh renewable capacity again,
Speaker 2: more than the US and Europe put together uh A
Speaker 2: a and if you look at what China is doing
Speaker 2: in terms of the energy transition in general, I would
Speaker 2: say that China is positioning itself and has already positioned
Speaker 2: itself as what I call the Saudi Arabia of renewables.
Speaker 2: Um China, I I uh uh if you look at
Speaker 2: different renewable technology segments, uh accounts for anywhere between more
Speaker 2: than half to sometimes 95% of the production or the capacity.
Speaker 2: Uh it the 95% would be for things like poly silicon.
Speaker 2: Um
Speaker 2: and this uh puts China in a really important position
Speaker 2: as the world itself engages in the energy transition. I
Speaker 2: think the energy transition is the single biggest
Speaker 2: uh macroeconomic structural change that is happening in the next
Speaker 2: few decades. And China is there to be uh uh a,
Speaker 2: a near monopoly or a provider of a lot of
Speaker 2: those technologies. Now, of course, this uh
Speaker 2: does not mix well with the geopolitical tension and friction
Speaker 2: that we're seeing across the world. Uh But China is
Speaker 2: definitely uh uh AAA very important player in climate and
Speaker 2: global decarbonization and will remain so for a very long time.
Speaker 1: Yeah. Um I think, you know, some of our mutual
Speaker 1: acquaintances who have worked in Hong Kong financial sector and
Speaker 1: have gone on to the government of China. I mean,
Speaker 1: they sort of tell us that uh in terms of
Speaker 1: driver of growth, whether it is investment or innovation in
Speaker 1: the private sector and this is one area, the authorities
Speaker 1: have absolutely no qualms about holding them back. They're sort
Speaker 1: of unleashing all the talent that they can and it
Speaker 1: is very, very encouraging.
Speaker 1: Well, finally question on the role of Chinese capital. Uh
Speaker 1: I mean, every time I travel around the world meet
Speaker 1: clients counterparts, it's all about China plus one corporate strategy
Speaker 1: and who's strategizing and reducing their presence in China and
Speaker 1: building in ASEAN? And I, I think that's an interesting
Speaker 1: narrative and there's a lot to talk about it, but
Speaker 1: a lot of the times what is absent in that
Speaker 1: conversation is what are the Chinese companies doing in the
Speaker 1: middle of all these
Speaker 1: uh shifts? Uh So talk to me a little bit
Speaker 1: about the role of Chinese capital. I mean, are the
Speaker 1: Chinese companies just sitting around and watching the whole world
Speaker 1: reshape or they're actually part of this uh reshaping that
Speaker 1: is going on?
Speaker 2: Yeah, another great question. I'm uh and I think that
Speaker 2: this is also very much underappreciated. I think it's a
Speaker 2: huge development. Uh And, and uh the reality of what
Speaker 2: the Chinese companies are doing is much more complex than
Speaker 2: is commonly described.
Speaker 2: The common narrative is that China has become expensive and
Speaker 2: firms are choosing to manufacture elsewhere. And that the geopolitical
Speaker 2: tension is driving investment away from China. And both of
Speaker 2: those factors have a grain of truth, of course. But
Speaker 2: the dynamics are much, much more complicated. Um
Speaker 2: a little fact to set the the the landscape here
Speaker 2: uh a few years ago, uh on a huge proportion
Speaker 2: of China's outward foreign direct investment was directed towards securing
Speaker 2: natural resources. It was basically in mining Chinese companies were
Speaker 2: going out there to find oil resources, coal resources, lots
Speaker 2: of other resources and some of
Speaker 2: that is still going on. Of course, including with critical
Speaker 2: minerals for the energy transition. But the largest area of
Speaker 2: Chinese outward FD I now is in manufacturing. Chinese companies
Speaker 2: have reached the point in the global development where they're
Speaker 2: taking the the the outsourcing steps that developed world companies
Speaker 2: took a few decades ago.
Speaker 2: Importantly here and probably under recognized in many parts of
Speaker 2: the world is that the global appeal of Chinese electronics,
Speaker 2: certain kinds of industrial goods and especially as I mentioned earlier,
Speaker 2: the energy transition technologies is huge. Last year, China became
Speaker 2: the second largest exporter of automobiles in the world. It
Speaker 2: overtook Germany this year. It is set to overtake Japan
Speaker 2: and become
Speaker 2: number one now just like in the developed country. Uh
Speaker 2: companies and the the developed world, Chinese companies are starting
Speaker 2: to follow their new customers and build facilities that cater
Speaker 2: to local markets. So you see all of these Chinese
Speaker 2: companies producing vehicles, industrial goods, uh energy transition technology
Speaker 2: set up shop, not only in Southeast Asia, but also
Speaker 2: in parts of Europe in the Americas. And even despite
Speaker 2: the geopolitical headwinds, lots of Chinese companies are trying marginal
Speaker 2: amounts successfully to actually invest in the United States uh itself.
Speaker 2: And so uh China is an active participant uh in
Speaker 2: uh the global reshuffling of supply chains in the regionalization
Speaker 2: of supply chains is also very important here. I think
Speaker 2: that much more than decoupling. We should talk about regionalization
Speaker 2: and the world
Speaker 2: uh shifting to different blocks. And of course, the Asian
Speaker 2: block of, of which China is the central participant is
Speaker 2: uh already and likely to uh increase in importance as
Speaker 2: the most important uh part of, of, of the, of the,
Speaker 2: of the world's uh supply chains. So
Speaker 2: um maybe I'll, I'll leave it there. I think that
Speaker 2: uh these developments are, are very, very important, they will
Speaker 2: determine what the global production landscape looks like in the future.
Speaker 2: And it's important to understand that uh China is not
Speaker 2: uh a, a uh a bystander there. They are an
Speaker 2: active participant in this process.
Speaker 1: Uh Santiago, the common refrain in this conversation that Jovan
Speaker 1: and I have just had is the sort of the
Speaker 1: urge to, for people to sort of appreciate the complexities
Speaker 1: of a country that is as large as China, I
Speaker 1: think uh brushing it with, you know, one broad stroke
Speaker 1: is a, you know, is a mistake, but it's also
Speaker 1: a dangerous mistake. So I hope that, you know, the
Speaker 1: listeners who are, you know, fortunate enough to hear your
Speaker 1: wisdom today
Speaker 1: would at least take that key insight away. Uh I
Speaker 1: thank you so much for your time and insights. This
Speaker 1: has been a fascinating conversation.
Speaker 2: Thank you timer. Thank you for having me.
Speaker 1: It's been great to have you. Uh Thanks to our listeners.
Speaker 1: Uh COVID time is for information only and it does
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