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CONFIDENTIAL AND PROPRIETARYAny use of this material without specific permission of McKinsey & Company is strictly prohibited
June 26th 2014
Dublin
Where is China’s Economy Headed?
McKinsey & Company | 1
Overview
Next Wave of China Opportunities
Evolution of China’s Economy
McKinsey & Company | 2
China economic trends: Summary
▪ Government promotes shift to domestic consumption and services
▪ Middle class becoming the new mainstream – far beyond tier 1 cities
▪ Cost increase and margin pressure across industries
▪ Urban markets continue to evolve in city clusters
▪ Digital unfolding disruptive momentum
▪ Local innovation at scale – by MNCs and local companies alike
▪ Some broader concerns & risks to watch out for
McKinsey & Company | 3
Among the reforms in the 3rd Plenum , market mechanism and sustainable development are important guiding principles
ENABLE AN EFFICIENT MARKET MECHANISM
▪ Allow the market to play a “decisive” role in resources allocation; apply market-based pricing except for important public services and industries with natural monopoly
▪ Reduce entry barriers to introduce competition from private sector
▪ Enhance the governance and management SOEs
STREAMLINE RELATIONSHIPS BETWEEN GOVERNMENTS AND MARKET
▪ Streamline the responsibilities of central vs. local governments, including the local tax breaks
▪ Increase fiscal transparency, especially for local governments
▪ Reduce government intervention and SOE advantages
▪ Separate jurisdiction system from administrative branch
IMPROVE SUSTAINABILITY OF ECONOMIC DEVELOPMENT
▪ Incorporate environmental protection into government officials' performance review
▪ Enhance balanced growth in population in the long term
IMPROVE SOCIAL FAIRNESS
▪ Enhance farmers’ property/land rights
▪ Grant rural and urban residents fair access to public services
Ensure top-level design with the Leading Group for the Comprehen-sive Deepening of Reform
Enhance cross-department coordination with State Security Committee
SOURCE: Literature search; McKinsey analysis
McKinsey & Company | 4
Upper middle class becomes the new mainstream
SOURCE: McKinsey Insights China – Macroeconomic model update, April 2012
Average annual household income (class)USD
Urban householdsMillions
100% = 2562012, %
100% = 1652002, %
Change in number of households2002-22, millions
100% = 3572022E, %
Poor<9,000
Upper middle class16,000-34,000
Affluent>34,000
Mass middle class9,000-16,000
2
1
90
7 54
14
3
29
22
54
9
16
66
-92
188
29
McKinsey & Company | 5
Geographic epicenter of the middle class shifts
SOURCE: McKinsey Insights China – Macroeconomic model update, April 2012
1 Based on the information for 266 cities
URBAN CHINA
Share of middle class by city tier1
Share of middle class by inland and coastal China1
31
43
45
40
16
815
3
2002
Tier 4
Tier 3
2022E
Tier 1
Tier 2
Inland China
Coastal China
Tier 1 cities
87
61
13
39
Coastal
2002 2022E
Inland
McKinsey & Company | 6
Manufacturing shift from growth to productivity
Revenue CAGR, percent
13
14
15
20
23
Specialtychemicals
Communicationsequipment
Automotive
General & specialpurpose machinery
Iron & steel
9
10
6
11
7 -16
-9
-9
-5
-4
1990-2010 2010-2020
Manufacturing sectors in China
Change
McKinsey & Company | 7
WagesOffice space
Water
7.8%
11.4%
4.6%
Business input costs continue to rise
Consumer price index
2.1%
3.5%
Interest rates
Producer price index
1.1%
China Shanghai
Annualized cost increases
2010-2013, CAGR
McKinsey & Company | 8
2012
6.2%
2011
7.1%
2010
7.7%
4.8%
2013 20132012
4.6%4.5%
2011
5.7%
2010
6.7%
Margins falling
Operating margins of Chinese industrial companies
1 WIND Industrial sector
State-OwnedEnterprises Listed companies1
McKinsey & Company | 9
Estimated penetration, 2013 end:
▪ Broadband: 40%
▪ Smartphone: 30%
Forcing new business models on:– Developers– Consumer service
providers– Financial services– Logistics
China’s e-tailing market size, 2003-20 in 2011 USDUSD billions
10
8
10
35
32
21
Low case
Base case
High case
CAGRPercent
World’s largest e-tailing market
2011-15 2015-20
183
120
7444
22
420
259
100
99
2020
648
128
15
395
37
121110092008
Reached US 2008 size
Reached US 2011 size
McKinsey & Company | 10
E-tailing hotspots
Mobile Luxury
B2C apparel Cross-border
McKinsey & Company | 11
Innovating sectors deepening
BiotechInternet Mobility Medical products
+18%+52% +62% +20%
YoY growth of internet economy
in 2008-12
YoY growth of biopharma in 2010-12
YoY growth of smartphone installed
base in 2008-12
YoY growth of medical products in 2010-12
McKinsey & Company | 12SOURCE: McKinsey database; industry reports; McKinsey analysis
65
Implantables
35
6560
60
40
Capital equipments
40
Lo
cal
MN
C
25
Other high-value medicaldevice
75
In-vitroDiag-nostics
35
Personal medical equipments
Locals are competing with MNCs across many segments – medical example
Product category
Mark
et
seg
men
t
1 Not including low-value medical products which accounting for ~USD 11 bn
Overall local share is ~40%
Estimated market size by product category and by customer segment, Bn USD, %, 20131
McKinsey & Company | 13
Key business issuesPercent of respondents
Worries about doing business in China?
18
19
32
35
37
47
50
61
MNCs Chinese companies
0
31
69
62
38
23
23
54
▪ Growing sophistication / shifting needs of consumers
▪ Intensifying competition
▪ Increased pressure from retailers
▪ Expanding influence of internet
▪ Changing channel dynamics
▪ Others (e.g., Government policy)
▪ Slow-down of Chinese economy
▪ Inflation and rising cost of doing business
McKinsey & Company | 14
McKinsey & Company | 15
Real Estate & Banking Concerns
SOURCE: McKinsey Global Institute, UBS
Real Estate
▪ Property starts likely down 10-15% this year
▪ Prices falling in 3rd and 4th tier cities
▪ Property developers investing outside China and talking down the market
▪ Supply exceeding demand as investor demand falls, taxes rise
Banking
▪ Wealth management products reaching US$2trn – raising cost of funding for banks
▪ New internet banks accelerating the trend
▪ US$350bn of wealth management products to be rolled over this year
▪ Government carefully managed any defaults to date
Common issue: Middle class confidence and willingness to
spend
McKinsey & Company | 16
Mall developers go bankrupt—especially state-owned ones
New South China Mall, Dongguan – Largest shopping center in the world when opened in 2005, now 99% empty
Vacancy rates, 2013Percent
10Guangzhou
Shenyang 17
Chengdu 16
+38%
Planned increase in mall capacity, 2013-2015
McKinsey & Company | 17
Overview
Evolution of China’s Economy
Next Wave of China Opportunities
McKinsey & Company | 18
▪ Urbanization: 15-20 million p.a.▪ Urban incomes rising 10-15% p.a▪ Urban expenditures rising 12-15% p.a.
▪ 51% households will be “New mainstream” by 2020: trade up, spending shifts to services
Drivers of Domestic Growth
Agricultural modernizationCompletion of energy and social infrastructure– modern and green
McKinsey & Company | 19
Economy moving to private consumption and services
Real GDP growth decompositionPercent, percentage points
Others
Net trade
2020E
27%
15%
40%
2005
11.3
Privateconsumption
Investment
6.6
1%
42%
20%
46%
18%
36%
2015E
7.5
2%
18%
13%
39%
2010
10.4
-1%
28%
59%
Examples of high-growth industries:
E-tailing
Protein
Tourism
Entertainment
Private education
Private healthcare
Logistics
IT services
A
B
F
G
D
E
C
H
9%7%
46%
10.4
47%
2005
11.3
48%
2015E
7.5
44% Industry
2020E
Agriculture3%3%
55%52%
42%
43%
6.6
Services
2010E
McKinsey & Company | 20
Implications for Industrial Sectors
1. Smart cities with cleaner energy, better resource utilization
3. Privatization and productivity
2. China Incgoing global
McKinsey & Company | 21
By end of 2013, 193 cities in China have rolled out ‘smart city’ projects
Chengdu
Daqing
Shenyang
Jining
Fujian
Hefei Wuhan
Nanchang
Guangzhou Guangxi
Shanghai
Shijiazhuang
Xi’an
Guiyang
Xiamen
Shenzhen
Chongqing
Mudanjiang
DalianBeijing
Tianjin
Tangshan
Langfang
Kunming
FoshanJiangmenDongguanZhongshan
Quanzhou
Fuzhou
Wuxi Suzhou
Ningbo Hangzhou
Wenzhou
TaizhouShaoxing
Wuhu
Nanjing
YanchengZhengzhou Kaifeng
Xuzhou
Jinan Zibo Qingdao
Yantai
Jiaxing
Yangzhou Zhenjiang Changzhou
SOURCE: press search
Majors cities having ‘smart city’ projects
Tier 1 city
Tier 2 city
Tier 3 city
McKinsey & Company | 22
2. China Inc Going Global: Outbound M&A
IndustryGeography
3
7
4
3
2
19
47
1
4
Food/agriculture
Infastructure/RE
Finance
Metals
Chemicals
Mining
Energy
2
Consumer excl. food
Auto/aeronautics
Tech
Travel/logistics
Other
Healthcare
6
11
5
4
5
North America
Western Europe
Hong Kong/Macau
Latam
Australia/NZ
Africa
Southeast Asia
Other
27
24
12
12
11
Percent of 2008-2013 (Oct.) outbound M&A100% = $267 billion
+
+
++
+
+
++
McKinsey & Company | 23
3. Privatization and productivity
SOURCE: McKinsey
Since 3rd Plenum, local and central governments preparing to bring more private capital in. Preparations nearing completion. Examples include:
▪ Sinochem proposing to sell downstream retail assets
▪ Chongqing has 100 local business from food processing to steel preparing to bring in private capital
▪ Guangdong looking to reduce holdings in water, logistics, travel companies
▪ Shanghai selling local SOE shares to PE firms such as Hony
▪ No barriers to non Chinese capital
CONFIDENTIAL AND PROPRIETARYAny use of this material without specific permission of McKinsey & Company is strictly prohibited
June 26th 2014
Dublin
Where is China’s Economy Headed?
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