It has taken China more than three decades of rapid urbanization and persistent high growth rates to get to where we are today, and the Chinese economy is now entering a “new normal” that requires sustained efforts to re-balance its fundamental economic structure to focus on stable, single-digit, growth driven by the consumer. Beijing’s recently announced “13th Five-Year Plan” aims to achieve a balanced and stable society, and reiterates the 2010 target to double GDP and GDP per capita income of urban and rural residents by 2020, requiring annual growth rates of at least 6.5%. To achieve these goals, China is making economic structural adjustments and undertaking an industrial transformation from a supply-led, or “push” model, to a demand-led, “pull” model. According to China’s National Bureau of Statistics, private consumption contributed 32% of the GDP growth from 2005-2010, 41% from 2010-2015, and is expected to reach 48% in the next 5 years. Private consumption will become the most important driver for China’s economic development.
To support the development of China’s “new normal” and a focused consumption-driven economy, the policy makers have announced a series of initiatives to serve as the framework for this transition, such as promoting individual income tax reform in an effort to drive an increase in disposable income and further relaxing the one-child policy to re-balance socio-demographics. Additionally, industrial policy reforms have been announced to upgrade and modernize general productivity and improve product quality.
These policies are conducive to Lunar’s investment strategy and focus, and are well-aligned to provide tailwinds for our portfolio – income tax reforms are expected to increase the disposal income of middle-class families and will lead consumers to increasingly favor safe and reliable products. Meanwhile, consumers are pursuing higher quality and healthier lifestyles, choosing products such as Joysun’s beverages and Yonghong’s beef jerky for their taste and reliability. A recent “Insight Report on the Two-Child Era” by CVSC-TNS RESEARCH, a leading domestic market research firm, noted that more than 70% of one-child families surveyed intend to have a second child, and given the relatively high propensity to spend of these families, middle and high-end baby products will be the primary beneficiaries- positive signs for brands in our portfolio like Yeehoo, Peekaboo, Soho Baby and I Pinco Pallino.
In 2015, the PBOC cut interest rates five times, and at year-end the one-year benchmark lending rate stood at 4.35% and the one-year benchmark deposit rate at 1.5%. This lower interest rate environment is conducive for consumer spending. Further, Lunar partner Robin Song has noted that as bank deposits shrink and the frequency of deposits and withdrawals – or general banking activity – increases, commercial banks are finding it increasingly difficult to manage positions. Commercial banking reforms and adjustments will be made and the changing composition of deposits will increase the reliance on the interbank financing market, which may, in turn, increase liquidity risk and result in banks being increasingly selective as they approve loans. This will impact private sector lending, and private equity may find itself able to capitalize on the opportunity to deliver assistance, and provide a reliable source of financing for private businesses.
Although the days of double-digit growth rates in China have since passed, efforts made by policy-makers, driven by social demands, are increasingly encouraging. We look forward to implementing our investment strategy, focusing on consumer branded businesses, in 2016 as the environment becomes more conducive for our business to grow revenue, increase margins and achieve more attractive valuations for our investors.
