In brief

• To promote a high-quality development in the long run, profound adjustments to economic policies are expected in the next five-year plan (2021-2025) and long-term development plan by 2035, which will be discussed and approved at the 5^th Plenum of the 19^th CPC Central Committee.
• “Rebalancing” might be the essence of the new plan, against a background of an increasingly complicated international environment. Policies might be focused on the rebalancing between external and internal sectors, traditional and innovative sectors, and consumption and investment.    
• To achieve that goal, China might advocate for further marketization reforms, albeit with a domestic-oriented focus. At the same time, plans will be made to support the development of certain strategically important sectors, particularly agriculture, technology, health care and public services. A system of smarter state-led investments should be the key for success.
• For investors, the upcoming five-year plan might bring opportunities in the consumer goods, services and technology sectors. Listed companies in inner-land regions might also offer resilient returns. In the highly competitive environment, it is important to take an approach of in-depth analysis and active management.

WHAT IS THE FIVE-YEAR PLAN?

On July 30, at the Politburo meeting chaired by Chinese President Xi Jinping, it was announced that the 5^th Plenum of the 19^th CPC Central Committee will be convened in October. As the key agenda, the 14^th five-year plan (2021-2025) and a long-term development plan by 2035 will be reviewed and approved.

Since 1953, the Chinese government has been compiling plans for economic development every five years, which was only interrupted during the period from 1963 to 1965. Initially, the five-year plan was made and executed in a style of rigid planning economy, i.e. the government’s planning department set very detailed quantitative rules to decide prioritized sectors, allocation of resources and distribution of consumer goods. In the very early stage, this system helped to establish an industrial system from almost zero.

During its transition to a market economy, China kept reducing administrative methods in the plans, while economic incentives, including fiscal spending, monetary tools and financial policies, have been used to guide the flow of economic resources. Since the 11^th plan, the official expression was changed to “five-year guideline.” Thereafter, the government put emphasis on a list of key areas with strategic importance, while relying on the market mechanisms in the rest of the economy. Through the recent four five-year plans, China achieved continuous economic growth, and its GDP per capita improved from USD 959 to USD 10,262 from 2000 to 2019 (Exhibit 1).

China has achieved decent economic growth since the 10^th Five-Year Plan
EXHIBIT 1: CHINA’S ECONOMIC GROWTH
USD, GDP PER CAPITA

Source: CEIC, National Bureau of Statistics of China, J.P. Morgan Asset Management.
Data reflect most recently available as of 17/09/2020.

Compilation of the 14^th five-year plan was launched in November 2019 at the central and local levels. In October, the Central Committee at the plenum will debate new guidelines. Next March at the annual session of the National People’s Congress, all delegates will vote on the plan. During this period, various government agencies will also be making more detailed action plans to bring the blueprints into reality. Along with the five-year plan, a new long-term development plan by 2035 will also be unveiled. Targets will be set for a longer time horizon, and might be separated into the 14^th and 15^th five-year plan for execution.

What to expect from the new five-year plan?

The 13^th five-year plan will end this year, during which China has achieved the objective to build a moderately prosperous society (xiao kang she hui), according to the National Bureau of Statistics. On such basis, the target for the upcoming 14^th plan has been upgraded to achieve a high-quality, more efficient, fairer, more sustainable and safer development. In November 2019, Chinese Premier Li Keqiang hosted a meeting to kick-start the compilation of the 14^th five-year plan, at which he emphasized high-quality development should be achieved through a series of key policies, major reform measures and strategic projects.

Recently, amid escalating external tension, it has become increasingly critical for China to guarantee self-sufficiency in strategic resources, including food, energy and technology, as reflected by the latest policy announcement to establish an “internal circulation and dual circulation” development model. This requires large-scale and continuous investment into those prioritized sectors, as well as well-designed policies to mobilize the market power. 

Against such backdrop, we believe “rebalancing” might become a main essence in the new five-year plan. Policy priorities might include the rebalancing between consumption and investment, traditional and innovative sectors, and external and internal economy. Meanwhile, there might not be a specific target for GDP growth in the new plan, and qualitative goals could be used. This could allow some flexibility during implementation of the plan and avoid aggressive administrative interventions in the economy.

• Rebalancing consumption and investment. China used to rely heavily on fixed-asset investment to boost growth and stabilize demand during economic downturns. This led to elevated leverage in the economy and overstretched local government finances. Hence, domestic consumption has been stressed as a policy priority since the 12^th plan (2011-2015). Although consumption has taken over investment as the top growth contributor since 2011 (Exhibit 2), its weight in the economy is still far below those in developed economies, suggesting large potential to improve people’s livelihoods.

Consumption has become the top contributor to China’s growth
EXHIBIT 2: DRIVERS OF CHINESE GDP GROWTH
YEAR-OVER-YEAR CHANGE

Source: CEIC, National Bureau of Statistics of China, J.P. Morgan Asset Management.
Data reflect most recently available as of 30/06/20.

During the 14^th plan, people’s income and consumption might be raised through reforms in the area of tax and income redistribution. In addition, a balanced regional development strategy might help narrow the income gap between the coastal and inner-land provinces. To achieve that goal, state-led investment is still a necessity, while being implemented in a more efficient and intelligent way.

Structural upgrade of investments is also part of the rebalancing. “New infrastructure” investment will take the place of railway, highway and airports as the new channel for infrastructure investment. This includes 5G telecommunication, industrial internet, smart power transmission, high-speed railway, new energy vehicle system, big data center, artificial intelligence, etc. With better physical and virtual connections, differences among regions could be reduced, and key city clusters across the country will become new engines for regional development.

• Rebalancing traditional and innovative sectors. In order to achieve the high-quality development, policymakers will continue pushing for the upgrade of China’s industrial system. Technology sectors, particularly IT, health care, new-energy vehicles and advanced manufacturing, will be highlighted in the new plan. With the “new infrastructure” plan, China is trying to catch up in these sectors and strengthen local supply chains.

Unlike the situation during the previous five-year plans, the traditional investment with heavy government intervention might be less efficient in incentivizing innovation. Therefore, the government should leverage on market mechanism to provide sufficient incentives to innovative activities. A smarter policy system might include continuous stock market reforms to attract more financial resources from households and private companies into technology sectors; tax incentives, such as tax reduction for chip manufacturers, to strengthen their financial positions; and improved public-private partnerships in venture capital to finance early-stage research and development. 

During the past five-year plans, China was catching up with the developed economy in research and development expenditures (Exhibit 3). With new policies in place to support such expenditures on the private side, the momentum could last throughout the next five years.

China is catching up in technology development
EXHIBIT 3: RESEARCH AND DEVELOPMENT EXPENDITURE
%, AS OF GDP

Source: World Bank, J.P. Morgan Asset Management.
Data reflect most recently available as of 17/09/20.

On the other hand, the government will continue its efforts to improve the efficiency of its traditional sectors. Reforms to the state-owned enterprises (SOE) will continue over the next five years, through mixed-ownership reforms, mergers and acquisitions among SOEs and market reforms to SOE management systems, so as to improve their viability. Environmental protection will also be strengthened to reduce emissions and achieve green development. Finally, the principle of “housing is for living, not for speculation” might be reiterated in the new plan. New plans for land reforms, public housing construction and urban renovation will be made to maintain stable and healthy development of the real estate market.

• Rebalancing external and internal economy. In recent policy announcements, Chinese leadership repeatedly expressed concerns about the “obvious rise of instability and uncertainty” in the external environment. To mitigate the risks from a potential “decoupling” with the developed economies, the government is advocating to establish a development model focusing on “internal circulation” of economic resources. This is a new factor for consideration in the upcoming five-year plan, and it is also highly correlated to the other aspects mentioned previously.

Food (mostly soybean and maize for fodder usage), energy and semiconductor chips are the top categories on China’s import list. In the new five-year plan, guidelines might be proposed to enhance self-sufficiency of these products through measures to secure domestic supply and improve efficient consumption. Continuous investment is necessary to boost domestic production capacity, and a smarter incentive system should be designed to attract domestic capital and human resources into these areas.

Beyond industry-specific policies, the government is also leveraging on fiscal measures to promote the development of inner land. Middle and western provinces might receive more fiscal transfers from the central government, which could be used to support urbanization projects and public service spending. This is also a part of the efforts to improve domestic consumption.  

However, China does not mean to close its door to the rest of the world. In an official statement, the “internal circulation” should be supplemented by “dual circulation,” which means the connection should be maintained between domestic markets and the rest of the world as in the previous decades. Thus, export sectors should continue to play an important role in job creation. Meanwhile, the authority will keep attracting foreign investment into the country’s manufacturing and services sectors and stock market. Import of foreign technology is still deemed as an important resource for domestic development, although it might become harder in the upcoming years.

What are the investment implications from the new plan?

In retrospect, during the period of the past eight five-year plans, China successfully made itself the world’s hub of manufacturing and realized continuous income growth, which reflects the advantage of a combination of market reforms and well-designed economic policies. Recent policy announcements about the new plan suggest the traditional pattern might be continued, while improvements will also be made on both sides of reforms and government supports.

For investors, implementation of the 14^th five-year plan implies growing opportunities to benefit from economic growth and restructuring in China. Investment themes might include:

• Continuous growth in household income and consumption. Market share might continue centralizing to sector leaders in consumer goods and services, boosting their corporate earnings growth and valuation.
• Technology development. Tax incentives and favorable financial policies will support booming research and development activities by domestic tech firms in the near future. Thanks to the huge market, domestic technology firms have the potential to achieve economy of scale and boost their profitability. During the course of stock market reforms, more companies with cutting-edge technologies are being listed, hence investors will have more room for stock picking and active management.
• Growth in inner-land regions. As a result of improved infrastructure, China’s middle and western provinces are catching up in terms of GDP and income growth, particularly in regions around major city clusters. On the low basis for land and labor costs, higher growth rates might be achieved by companies in those regions. Being domestic oriented, companies in these regions are likely to be resilient amid a rising external risk. 

The above changes have been happening over the last decade, as reflected in the stock market. In terms of A-share market cap, the shares of information technology, consumer discretionary and staples have picked up significantly since 2010, while the industry sector’s weight kept declining (Exhibit 4). The financial sector remains on the top of the market cap rank after reforms in the 2000s, during which a large number of banks and other financial institutions went public. However, inside the sector there has been significant structural change. Banks and insurers that adopted cutting-edge technology and provided high-quality consumer services are taking more market share, reflecting the increased consumer demand for financial services.

Technology and consumer sectors are becoming more important in China’s stock market
EXHIBIT 4: A-SHARE SECTOR COMPOSITION
% AS OF MARKET CAP IN A-SHARE MARKET

Source: Shanghai Stock Exchange, Shenzhen Stock Exchange, Wind, J.P. Morgan Asset Management.
Data reflect most recently available at 17/09/20. 

That said, the number of listed stocks has increased very quickly in recent years, probably leading to difficulties in managing a China portfolio. In this highly competitive environment, it has become increasingly important for investors to take an approach of in-depth analysis and active management in the China market. 

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