Letter from China

MY LAST article cautioned South African businesses to not miss out on China’s growth. Maybe due to misconceptions about China, what may have been overlooked is the fact that China’s merchandise trade is not the only aspect that is growing at a phenomenal rate.

National statistics showed the services sector accounted for 44.6% of China’s gross domestic product last year.

According to the World Bank, this figure is very low compared to China’s peers, who typically have ratios of 55%-75%, with 63% as the world average.

This simply emphasises the potential growth available to those willing to capture it.

China’s focus for the past decade has been on capital and energy intensive industries due to subsidised electricity, credit and land, as well as a cheap yuan (renminbi), leaving services unnoticed and unattended.

As many economists have pointed out, China cannot overly depend on exports and inward investment to fuel its growth for much longer.

The solution to this conundrum, which has already been stated numerous times, has been to spur domestic consumption. This has led, and will continue to lead, to a surge in demand for services that satisfy the ever growing needs and wants of the newly created middle-income bands in China.

This emerging middle-income group, which is already estimated at more than 300-million, is scattered throughout China’s cities and will continue to grow (thanks to a high urbanisation rate) and will be in need of services as it earns and spends more money.

China’s leadership is fully aware of the need to focus on domestic consumption to reduce its dependence on investments and exports for growth, and have made it a priority in its latest five-year plan.

In addition, the services sector traditionally increases employment at a higher rate than industry, which is of great importance to a country needing to avoid social unrest by reducing its income inequality gap and keeping unemployment figures down.

Since China is well known for its ability to get behind an initiative that the central government has created, expecting a surge in growth and focus on the services sector is not outlandish.

The Chinese government has already begun to take steps at raising consumer confidence by expanding its public health insurance cover to almost all of its rural citizens. The state subsidy for health insurance is set to rise 18% from last year’s budget, equating to raising the reimbursement of hospital expenses from 50% to almost 70%.

Furthermore, in the first half of last year, 16 provinces raised the minimum wage by an average of 19.7% and another 12 raised the government reference wage by an average of 14%.

Domestic consumption is one of the most important drivers of growth in the service sector and because consumer confidence largely drives consumption, these initiatives, along with many more expected to follow, will begin to give Chinese consumers the confidence to spend more instead of saving (lowering their savings rate from the high of 42%).

This eventual change towards private consumption being the largest sustained contributor of growth, and the slight decline of investment, should not come as a surprise, as it follows a similar pattern to other Asian countries such as South Korea and Japan.

About 10 months ago I mentioned that many Chinese firms in the services sector lag behind their international peers in service delivery and quality. This creates numerous opportunities for companies which have the ability to differentiate their product offerings as well as to provide the supporting skills and expertise.

I also said that large Chinese firms are and would expand out of China to buy and search for expertise, leaving medium-sized firms who remain in China — either unwilling or unable to expand out of China — as prime targets to partner with and capture the growth potential in China.

Certain South African companies have already taken advantage of this growth in China’s domestic market (those that come to mind are Discovery and Naspers). The growth and returns achieved by these investments have been due in part to a sound investment strategy but mainly due to the competitive advantage each of them was able to provide their Chinese partner through product innovation, operational efficiencies and meeting consumer needs better than their competitors.

What often sets South African firms apart from say, European or US-based companies, are the lessons learnt from operating in difficult and diverse markets throughout South Africa and Africa.

Bringing these experiences and combining them with China’s large market could lead to a prosperous venture. While China might be well known for its appetite for minerals and being the factory of the world, let us expand the view and deduce that like many previous countries transitioning from low to middle income, the services sector is paramount to that transition and China is readying itself for a surge. Get on board now.

• Van der Wath is Group MD of The Beijing Axis. He can be reached at kobus@thebeijingaxis.com