[Marketing with Trend] Supply-side Reform Promises Enormous Opportunities for Equity Investment Inst
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Ever since November 2015, supply side structural reform has become a buzzword. Supply side reform reflects the top officials’ new thoughts about the “new normal” of economy, and it is in line with the internal demand of economic structural reform and industrial upgrading in China. In such context, equity investment institutions will play an important role in driving the sound development of Chinese economy.
Supply reform is the essence of industrial reform
In the short term, the demand end has a greater impact on economic fluctuation; while in the long term, supply side plays the decisive role. Looking back on our economic history, every critical economic leap is originated from the revolutionary improvement of supply capacity.
The development level and potential of an economy is decided by its supply capacity. Modern economists believe that factors that affect the supply capacity of an economy include labor, capital and technology, while the leap of supply capacity in the order of magnitude results from technological innovation. From agricultural to industrial society and then to post-industrial society, every great leap we human beings take are results of supply upgrading led by technological innovation. In the 18th century, a series of inventions like the steam machine ushered in the first era of industrialization—the steam era. In middle and late 19th century, electrical revolution gave rise to electrical society and brought fundamental changes to the world’s appearances and to human’s life style. During the third science and technology revolution started in the mid-20th century, we entered the information era based on computers and the internet. It is predicted that in the 21st century, new technological revolutions will promote new leaps forward in our supply capacity.
Technological reform brings about industrial evolution, which further leads to supply upgrading—this is a positive economic development cycle. When there is no obvious increase in productive efficiency and supply capacity, it is not sustainable to simply maintain economic growth on stimulus from the demand side. Serious financial crisis in human history are all caused by the imbalance between supply and demand. For example, the crisis in 2008 is exactly the consequence of such imbalance, and nations have since adopted easing policies to merely stimulate short-term demand, which failed to fundamentally solve the economic imbalance situation. Therefore, global economy is still in a downturn today.
Propelling a new round of technological revolution and supply upgrading is the fundamental solution to the current global economic crisis. From the “Industrial Internet” of the US, to “Industry 4.0” of Germany, to “Made in China 2025” of China, every nation is looking for a way of breakout in the new round of supply upgrading. The theme of the 2016 winter Davos “Mastering the Fourth Industrial Revolution” more explicitly regards the new round of technological revolution as a new impetus of world economic growth.
From demand to supply—an era of upgrading in China
Continuous reform in the past 30 years has comprehensively improved the potential production and supply capacity of China, an emerging economy, and completely changed China’s appearance. Since the adoption of reform and opening up policy, supply upgrading has always been a key topic for China. Economic reform originated from rural China at the end of the 1970s broke the constraint on productivity imposed by the traditional system, fully mobilizing the potential of more than a billion people and upgrading the efficiency of production factors in China. Since Deng Xiaoping made his speech when inspecting the Southern China in 1992, China has basically completed a round of reform regarding price, finance, fiscal policy, exchange rate, housing and social security system, disposed large amount of state-owned capital, and fundamentally formed a market economic system.
Entering the new century, supply upgrading brought about by institutional reform slowed down relatively, while investment and export from the demand side became the main engine for Chinese economic growth. The long-lasting high saving rate has provided capital foundation for high investment in China, and investment on real estate and infrastructures became the leading force driving domestic demand. Meanwhile, joining the WTO provided a perfect external environment for China. China soon emerged as the largest industrial country and trading country in the world by taking advantage of the dividend of globalization.
Although we cannot ignore the important role of investment and export in driving Chinese economic growth, simply relying on increasing investment on production factors and export expansion to propel economic growth will surely face bottlenecks. After the 2008 financial crisis, government’s injection of “4000 billion yuan” stimulated a new round of expansion on physical productive capacity; however, around 2011 and 2012, such capacity reached its peak and the population dividend has started to fade. Besides, the giant investment stock of real estate can hardly be digested; extensive growth led to serious ecological and environmental pressures; and the traditional stimulation pattern could no longer sustain.
In China, “supply side reform” means not only stabilizing growth in the total quantity, but also adjusting economic structure. At the Third Plenary Session of the 18th National Congress of the CPC held at the end of 2013, the topic of comprehensively deepening reform was initiated; and the top decision makers released a clear signal on realizing long-term sound economic development based on the dividend of reform, rather than maintaining short-term growth relying on demand stimulus. Under this circumstance, Chinese economic policy started to transform from emphasizing on demand side management to improving the efficiency at the supply side. In the latter half of 2015, “supply side reform” was officially set as the key strategy in tackling with the economic “new normal”, signifying that China will make institutional reform and technological innovation the internal motivation for supply upgrading and economic growth.
Finance + real industry, equity investment institutions assisting in resource allocation optimization
In the process of supply side reform, not only supply of products and services requires for upgrading, but also supply of capital and institution. Upgrading of products and services is critical to the industrial orientation of equity investment, while reform of institutional supply system will influence its market structure and business model.
According to international experiences, since the late 20th century, equity investment institutions have proved critical for propelling real economy growth. PE contains the characteristics of both financial capital and industrial capital. As typical financial capital, PE profits from the price difference between investment and withdrawal, while as typical industrial capital, PE holds equity for a medium and long term, thus is able to participate in the investees’ operation, management, efficiency improving, and resources integration as a main shareholder, which typically resembles typical industrial capital.
PE capital, with both financial and industrial characteristics, has the most powerful social resources allocation capacity among all capital forms. In mature industries, equity investment institutions build leading enterprises, optimize industrial patterns and promote industrial upgrading and evolution through M&A investment; while in emerging industries, they scout for promising fast-growing enterprises and propel innovation and entrepreneurship by means of venture capital investment. It is fair to say that equity investment institutions have become the main force promoting market restructuring, enterprise innovation and development, and resources allocation optimization in various industries and fields. In the context of recent economic transformation and restructuring in China, these institutions will also have a great role to play.
Five major tasks to realize supply upgrading, where equity investment institutions are expected to make major contributions
When proposing “supply side structural reform”, the Central Economic Working Conference also made clear five major short-term tasks: de-capacity, de-stocking, de-leverage, reducing costs and shoring up weak spots. The substance of such tasks is to adapt to medium and high-end demand growth with corresponding growth in productive capacity; to replace outdated capacity with efficient one; to reinforce industrial structural weaknesses with hi-technologies; to decrease the cost for real economy with advanced market institutional arrangements; to guarantee livelihood of the vulnerable groups with comprehensive social security policies; and finally to increase the volume and quality of valid supply while moderately expanding the general demand.
Actively participate in dissolving excess capacity
Equity investment institutions can help enterprises with excess capacity to reorganize by “merger of similar items”. In this process, the best entrepreneurs in the industry can manage as much assets as possible and the best enterprises can integrate technological resources in the industry, so as to optimize the governing approach of assets, to firmly clear and divestiture low-efficient assets, and finally to restructure and improve the efficiency of the whole industry.
2. Assist in the de-stock of real estate in multiple ways
Equity investment institutions can directly purchase real estates and conduct a series of integration; they can also invest in real estate innovative financial products including RELTS. On the Central Economic Working Conference and Central Urban Working Conference held at the end of last year, the top officials emphasized on combining the transference of migrant workers into citizens and dissolution of real estate stocks by encouraging migrant workers in second and third-tier cities to settle down and digest local house stocks, with part of migrant workers renting houses. This will create favorable conditions for the development of financial derivative products operating on the basis of rental cash flow.
3. Help local government to lower leverage rate
In the past, local governments have long relied on infrastructure construction and balancing debt with income from selling lands. This can hardly continue, as high systematic risks accumulated on local debt platform. The focus is always on preventing and resolving financial risks and reducing local governments’ leverage rate. Equity investment institutions can actively involve in this process. In order to give full play to limited fiscal resources, local government will implement the PPP model through actively introducing private capital in the construction of municipal public facilities. While leading industrial structural upgrading and adjustment, the local governments will replace the traditional direct fiscal subsidies with industrial development funds and other innovative patterns. PPP and other various industrial development funds are areas that equity investment institutions can profoundly get involved in.
4. Help effectively lower financing cost for real economy
One important method to lower financing cost for enterprises in the real economy is to expand direct financing, which requires rapid development of equity investment first. Compared to credit financing, equity asset is not loans, nor does it need mortgage guarantees required by traditional credit financing. Therefore, it can better satisfy the financing demand of medium and small-sized enterprises with a growing potential. Second, it requires to lower the threshold for enterprises to finance through public market, and accelerate the construction of a multi-layer capital market represented by the National Equities Exchange and Quotations (NEEQ) market. Third, it requires more innovative financing products for enterprises to finance directly in a more diverse manner. The second and third aspects of the reform are beneficial to the development of equity investment industry. As the initiation of a registration system, strategic emerging board and the continuous rapid development of NEEQ, the marketization reform direction of the capital market also provide a more convenient exiting route for equity investment.
5. To comprehensively promote industrial upgrading and evolution
First, the equity investment institutions can help the top Chinese enterprises to actively conduct merger and acquisition overseas, combining domestic capital, labor and market advantages with the technology, brand, and intelligence property abroad to further optimize enterprises’ product structure, improve enterprises’ competitiveness and realize the effect of “1+1>2”. Second, they should give more emphasis on innovative technologies, products and business patterns while making growth investments, enhance support for enterprises in emerging industries, help innovative start-ups to solve their capital difficulties in their growing period, and build new leaders in the area of emerging industries.
Supply upgrading: challenge as well as a key historical opportunity
Since the onset of international financial crisis, the global economy has always been faced with key challenges. However, a new wave of economic adjustment also contains the historical opportunity of a new round of economic leap. As equity investment institutions, if we can find the right direction and successfully promote economic and industrial structural adjustment and upgrading, we can take the initiative in the competition of the equity investment industry or even the whole financial industry.
On one hand, the current Chinese economy needs to eliminate large amount of excess capacities as old industries and old business patterns slump. On the other hand, the trend of “innovation and entrepreneurship by all” is in the ascendant; new technologies, business patterns and models are developing rapidly; and the “Internet +” and “Made in China 2025” are leading the new round of industrial upgrading in China.
China is going through a comprehensive financial reform. With the introduction of the registration system of A-share listed companies, the launching of strategic emerging board initiated by the Shanghai Stock Exchange (SSE), and NEEQ’s adoption of the layer separation system, the construction of a multi-layer capital market is speeding up. The encouragement on enterprises to finance directly and to support industrial integration through merger and acquisition and other financial methods, the promotion on long-term capital to enter equity investment field will change Chinese enterprises’ way of financing and also the financial ecosystem in China. Equity investment institutions’ capacity in financial operation will play a more important role in promoting economic recovery.
Supply side reform is a structural adjustment and institutional reform with profound influences on the real economy and financial market. With both industrial and financial capital, equity investment institutions must perform excellently in this reform for its future development.
- Jiuding Group
- JT Asset Management
- JX AMC