Morgan Stanley
  • Research
  • Feb 15, 2017

The Next Decade of China’s Transformation

The latest act in its economic success story may see China achieve high-income status in 10 years, an unprecedented transformation for a country its size and one with far-reaching ramifications.

Morgan Stanley Bluepapers, a product of our Research Division, involve collaboration from analysts, economists and strategists across the globe and address long-term, structural business changes that are reshaping the fundamentals of entire economies and industries around the globe.

China’s transformation over the past 30 years can be illustrated in a number of dramatic ways: sleepy coastal towns turned high-tech manufacturing centers; Shanghai’s quaint riverfront sprouting an iconic skyline of financial might; its rise as a global economic powerhouse, second only to the U.S.

Here is another way to look at it: China’s per capita gross national income (GNI) of $290 in 1985 had nearly doubled to $540 by 1995, more than tripled to $1,760 by 2005, then quadrupled to $8,100 by 2016, according to World Bank data.

The future Chinese consumer will be richer, older and more tech-savvy.

This unprecedented lift from low to middle-high income status is now set for the next stage of an even harder climb. In a new Bluepaper report that melds analysis and insights from its macroeconomists, market strategists and sector specialists, Morgan Stanley forecasts that “China will break out of the middle-income trap and join the rarified ranks of high-income society” attaining per capita GNI of above $12,500 by 2027—a defining moment in its economic journey.

Getting there won’t be easy. Many barriers and pitfalls lie ahead, from industrial overcapacity and the need to reform its state-owned enterprises to elevated levels of debt, as well as the more recent risk of protectionism. Yet, for investors, companies and policymakers with a long-term view, Morgan Stanley offers a compelling map of China’s shift from export-driven manufacturing growth to an economy powered by domestic consumers and higher value-added sectors, from technology and energy to healthcare, education and more. 

China Is Expected to Achieve High Income Status by 2027

Source: World Bank, Morgan Stanley Research. E=Morgan Stanley Research Estimates. GNI= Gross National income.

Fear of Financial Shock

Skepticism abounds, and not without cause. Investors seem to be most concerned about the risks of a financial shock in China, similar to the Asian financial crisis in 1997-98 and the U.S. financial meltdown in 2008, which triggered a global recession, says Chetan Ahya, Morgan Stanley’s Co-Head of Global Economics and Chief Asia Economist. Of particular concern: China’s debt has risen from 147% of GDP in 2007 to 279% in 2016, a buildup that many fear is unsustainable. Reflecting their skepticism, investors now hold a decade-low underweight position in China equities, notes Jonathan Garner, Morgan Stanley’s Chief Asia Equity Strategist.

Still, China has proven its mettle in the past. In the aftermath of both global financial crises—in 1998 and 2008—even as many market stalwarts faltered, China held fast as an anchor of economic stability. Ahya and Garner believe that it can avoid the worst yet again, citing three major factors:

  1. China’s own savings have funded its buildup in debt, which has gone into investment, rather than consumption;
  2. The government enjoys strong net asset positions both domestically and externally. Both provide adequate buffers against shocks;
  3. Strong external macro positions, including a current account surplus, high levels of foreign currency reserves, and lack of significant inflationary pressures, leave China with plenty of leeway to manage domestic liquidity conditions.

That said, “China has borrowed a lot from the future, and the payback will be in the form of a significant slowdown in growth rates,” Ahya says. 

Base Case: Debt-to-GDP (%) Pace of Increase Expected to Slow

Source: CEIC, Morgan Stanley Research estimates

Slower But Higher Quality Growth

That slowdown is already under way. GDP growth has trended lower every year since 2010, when growth was 10.6%. From 2011-15, real GDP growth averaged 7.9%; Morgan Stanley projects an average real GDP growth rate of 6.1% from 2016-20, falling to 4.6% (2021-25) and 3.1% by the 2026-30.

Managed correctly, however, that is precisely the trajectory China wants. “To continue its journey toward a high-income society, China will need to move up the value chain in economic activities, shutting down capacities in old, redundant industries, while fostering the development of new, high value-added economic activities in sectors such as healthcare, education and environmental services,” says Robin Xing, Morgan Stanley’s Chief China Economist.

Consumption and services will come to dominate the economic landscape. Indeed by 2030, China’s private consumer market will reach $9.6 trillion and account for 47% of its GDP, up from $4.4 trillion and 39% of GDP today. “The future Chinese consumer will be richer, older and more tech-savvy,” says Angela Moh, who covers the consumer market in Asia, excluding Japan. By 2030, household disposable income will reach $8,700; the median age will rise to 43, and internet penetration will increase to 75%; compared to $5,000, 37 years old, and 52%, respectively, in 2016.

High-Tech Consumers

These trends will reconfigure China’s domestic market. Ecommerce shifts that are already in play in mobile tech innovation, electronic payments and banking, and online shopping will accelerate, says Moh. “Considering that by 2030, about half of the population in China will either have grown up with a smartphone or be sufficiently tech-literate to benefit from the sprawling eCommerce infrastructure, eCommerce is likely to remain a key driver of China’s consumption,” she says, adding that eCommerce is likely to drive growth in rural consumption in particular, as internet accessibility continues to improve.

Expect winners and losers. The sectors that are most likely to benefit: providers of high-end goods and services, as well as experiential industries, including auto, vacation travel, healthcare, household and electronic appliances, jewelry and luxury goods, and sportswear. Other sectors will likely suffer. “Food and beverage, home and personal care, and apparel and footwear industries in general will need to adapt to fast-changing consumption trends and overall lower allocation of spending on their products,” Moh says.

At the same time, China will ramp its competitiveness against other traditional leaders in high value-added manufacturing categories, such as telecom equipment, semiconductors, railways, power supply infrastructure and defense, says Garner. Even higher up the industrial supply chain, China’s efforts at home-grown automobile and aircraft manufacturing are also important to watch.

China services segment will also experience more growth. Areas such as healthcare, education, information technology, finance, and culture and entertainment are already adapting to demographic and economic shifts. Government and private investment are also expected to grow significantly in these sectors, reflecting the demands of an aging population, the growing market for high-tech skillsets and a wealthier, savvier consumer base.

What Could Go Wrong?

China’s climb to high-income status bears many risks. Indeed, only two other countries with a population of more than 20 million—Poland and South Korea—have achieved this feat in the past three decades. A lot can go wrong. The debt cycle may spin out. Unexpected headwinds, such as the recent increase in protectionism risks, may slow global growth. Yet, policy makers have signaled their resolve to focus more on preventing financial risks, indicating that they won’t protect growth at all costs.

“This gives us greater confidence that policy makers will be able to slow the pace of rise in debt-to-GDP and will focus their efforts on setting a more stable environment that can allow China's vibrant private sector and formidably resourced state-owned enterprises to move toward high value-added economic activities,” Ahya says.

For corporates and investors focused on the next stage of China’s transformation, significant market opportunities await. Referring to the benchmark index for global investors in China, Garner says: “We are confident that the MSCI China can continue its long run track record of outperformance of global emerging markets.”

MSCI China vs. MSCI EM: Total Return Rebased Index in US$ (Log Scale)

Source: MSCI, Morgan Stanley Research, monthly data as of Jan, 2017

This article is adapted from the Bluepaper report, “Why we are bullish on China” (Feb 13, 2017). Institutional clients can ask their Morgan Stanley representative for the full report, or access it directly. Wealth Management clients can ask their Morgan Stanley Financial Advisor for a copy, or access the report by logging into their Morgan Stanley Online account. Get more Morgan Stanley Research and  Ideas, or find a Financial Advisor.