Setting aside overly granular debates, let's look at a big-picture narrative from Weijian Shan.

By Jiaxiang Shi

Edited by Jing Liu

The world of 2023 was anything but peaceful. The Russia-Ukraine conflict dragged on, the Israel-Gaza war erupted, post-pandemic consumption recovery fell short of expectations, and Evergrande's long-anticipated collapse finally came. Yet even amid this turbulent macro environment, China's economy kept growing. On November 8, Pan Gongsheng, Governor of the People's Bank of China, stated at the 2023 Financial Street Forum that China's GDP grew 5.2% in the first three quarters of the year, putting the full-year target of 5% within reach.

That same day, at an investor conference in Hong Kong, Shan Weijian, Co-Founder and Executive Chairman of PAG, told investors: China's growth would most likely continue for the foreseeable future.

The statement was unambiguous in stance, yet conservative in expression — characteristic of Shan's style.

As founder of PAG, Shan is known in the industry as the "King of Private Equity." His life story traces the arc of China's generation born in the 1950s: his schooling cut short in youth, he spent a decade in the countryside as a sent-down youth during the Down to the Countryside Movement. In 1977, he became one of the first students to resume university education after the Cultural Revolution. When China and the US established diplomatic relations in 1980, only 1,860 people nationwide received scholarships to study abroad — Shan was among them. He later calculated that lightning strikes killed roughly 3,000 to 4,000 people in China annually at the time. Your odds of dying from lightning were higher than your odds of going abroad to study.

In 1997, Shan joined Newbridge Capital, where he completed two legendary deals. During the Asian Financial Crisis, amid Korea's complex web of government-business relations, nationalist sentiment, and commercial competition, he served as lead negotiator for Newbridge and secured control of Korea First Bank — then the country's largest commercial bank — from the Korean government. In 2004, with negotiations on the verge of collapse, Newbridge, with Shan at the helm, ultimately gained control of Shenzhen Development Bank. This marked the first and only instance of foreign acquisition of a Chinese national commercial bank.

In 2010, Shan founded PAG, serving as Chairman and CEO. His investment portfolio includes Yingde Gases, Zhenai.com, and Universal Studios Japan (USJ). By the end of 2021, PAG had exited $40 billion of its $70 billion in invested capital.

Of particular note, according to An Yong Waves (An Yong), if the rumored acquisition of Yingde Gases by Hangzhou state capital proceeds as planned, PAG's investment in Yingde could represent the largest single return in China's primary market in recent years.

Recently, An Yong Waves obtained a transcript of Shan's remarks at PAG's November 8 investor meeting. In it, he re-examined China's capacity to address economic challenges from monetary and fiscal perspectives. His core arguments include: China has already assembled the five key conditions for certain technological breakthroughs; green energy, digitization, industrial robotics, and AI will become new engines of Chinese growth following real estate; and "leading enterprises catering to private consumption" remain aligned with private equity investment preferences.

For more on Shan and PAG's story, see last summer's An Yong Waves interview.

China's "Five Conditions"

Shan's remarks began with the challenges facing China's economy.

China's real estate sector accounts for 11% of GDP, but since 2022 it has been a drag on economic growth — the primary factor behind the recent slowdown. However, Shan believes the sector's troubles may be easing. Citing Financial Times data, he noted that real estate's negative contribution to GDP growth has narrowed from roughly 4% in 2022 to under 2% in 2023.

Could real estate's slump trigger a financial crisis akin to 2008 in the US and Europe? Could Evergrande's crisis be "China's Lehman moment"?

Shan's answer: no.

Shan pointed out that the average loan-to-value ratio for mortgages in China's major cities is about 40%. This means prices would need to fall by more than half — leaving homes worth less than their loans — before properties become negative equity. And even then, Chinese residents cannot simply walk away from their mortgages as Americans can. In mainland China and Hong Kong, mortgages constitute unlimited personal liability. This is why, during the 1997 Asian Financial Crisis, Hong Kong's real estate market saw widespread negative equity without a single bank failure. Currently, real estate developers' outstanding loans comprise less than 6% of total bank lending, and all are backed by collateral.

On semiconductors, Shan argued that China's strong technological foundation gives it genuine catch-up capacity over the long term, and export bans will only motivate Chinese firms to develop new technologies.

The evidence bears this out. Since 2018, China has made leapfrog advances in new energy, semiconductors, and other fields.

When Shan was a professor at Wharton, his research focused on the biotechnology industry. His puzzle: despite Europe and Japan being wealthy developed nations, why were biotechnology and Silicon Valley uniquely American phenomena? He identified five factors: concentrated top talent, concentrated research institutions, accessible capital, deep manufacturing capability, and a sufficiently large market.

Now, he believes China has all five. This means catching up — and even taking the lead in certain technologies — is only a matter of time.

He cited reports from the Financial Times and Wall Street Journal for several examples —

China's savings rate stands alone among large economies, with gross national savings exceeding 40% of GDP;

China now publishes more scientific papers in prestigious journals annually than the US;

Chinese patent applications have grown "explosively," reaching 1.5 million per year — surpassing the combined total of the US, Europe, Japan, and South Korea;

China's R&D spending trails only the US.

Meanwhile, Chinese manufacturing is moving up the value chain, producing higher-value, higher-technology products and components. Manufacturing value-added as a share of global output continues rising, now reaching 31%.

On demographics, Shan offered a counterintuitive take. The prevailing view holds that China's aging population and declining numbers will ultimately impede long-term growth. But Shan's argument: the data doesn't support this. China's working-age population peaked in 2012 and has gradually declined since, yet GDP doubled in the decade that followed.

Improved R&D and productivity will also help China avoid the "middle-income trap," given its current leadership in industrial automation. For the foreseeable future, labor shortages are unlikely. Moreover, he noted that mandatory retirement ages remain too low — the workforce is not being fully utilized.

At the meeting, he recounted what an American investor told him: if the international investment community is bullish on Japan, which faces far more severe demographic problems, why not China?

Policy Space to Stimulate the Economy

Janet L. Yellen, current US Treasury Secretary and former Federal Reserve Chair, recently told reporters: "We see China's growth slowing over time. Nevertheless, China has considerable policy space to address these challenges."

Shan agrees. (Editor's note: Janet Yellen was Shan's doctoral academic advisor.) He argued that China has room for monetary easing through interest rate cuts, reductions in the cash reserve requirement, or both — a capability other major economies lack.

The reason: unlike other developed nations, China has not experienced inflation. October's consumer price index was -0.2%, core inflation (excluding food and fuel) was 0.6%, and the producer price index fell 2.6%. Moreover, China's real interest rates — nominal rates minus inflation — remain relatively high. Current lending rates hover around 4-4.5%, still above US levels and far above Europe or Japan.

Additionally, commercial banks' cash reserve ratio — the deposits they must hold at the central bank — stands at roughly 10.5%, compared to 0-1% at major Western banks.

On fiscal policy: fiscal space is inversely proportional to government debt. Less debt means more room for fiscal expansion.

Currently, central government debt is only about 21% of GDP. Including local government debt, both explicit and implicit, the IMF estimates total government liabilities at roughly 110% — still favorable compared to the US (140%) and Japan (260%).

Furthermore, all of China's land and resources are state-owned, including land, mineral deposits, and forests. Thus, China's overall fiscal position is far stronger than other countries'. Whether monetary or fiscal policy, China has substantial room to maneuver.

Bullish on "Leading Enterprises Catering to Private Consumption"

Of course, Shan's arguments do not mean China's real estate sector will escape short- or long-term pain — only that real estate problems will not cascade through the banking system. But if real estate no longer drives growth, what will?

Shan believes China is world-leading in industries propelling, and propelled by, the Fourth Industrial Revolution — green energy, digitization, industrial robotics, AI, and so forth.

This year, China surpassed Japan as the largest automobile exporter, with one-quarter being electric vehicles. Lithium batteries, critical for EVs, phones, and other industries, now account for 63% of global market share. Similar growth has occurred in wind power and industrial robot manufacturing.

However, he does not find most of these industries attractive for private equity investment. They tend toward excessive competition and overcapacity, leading to insufficient profitability.

So where lies the opportunity for PE?

Shan's choice: "leading enterprises catering to private consumption." Last year, in his An Yong Waves interview, he discussed their investment in %Arabica — a coffee brand born in Hong Kong and risen to prominence in Tokyo: "For any investment, the first judgment is whether it has uniqueness. This company's uniqueness lies in its brand and product characteristics." He elaborated: "%Arabica's products are far more refined than Starbucks', including when beans are roasted, how long after roasting they can no longer be used, and so on — the taste and quality standards are much higher."

Some argue that Chinese household consumption is constrained by household disposable income's relatively low share of national income. But according to The Economist, if welfare, social security, and other forms of government and non-profit assistance are included, Chinese household disposable income as a share of national income exceeds that of Sweden, South America, South Korea, Denmark, and others. Even with all this counted, however, private consumption is only 45% of GDP — far below the US's 72%. For investors, of course, this means enormous room for growth.

In his closing remarks, Shan acknowledged that China is not without economic challenges. For now, businesses and consumers remain pessimistic; the private sector will need several years of policy stability and concrete policy support to fully restore confidence.

But he repeatedly emphasized that China's economic fundamentals are sound, the economy has yet to fully realize its potential, the government has ample policy space to promote growth, and industrial development has laid a strong foundation for the future. "All of this indicates that China's growth will most likely continue for the foreseeable future."

Image source: IC photo

Layout: Xuemei Guo