It is not all doom and gloom. China is not heading for the hard landing that some of the bears have predicted following the country's sharemarket rout of recent weeks. But it is transitioning to a sustained period of more moderate growth, which will be led by consumer spending rather than heavy industrial investment.

While Credit Suisse's official forecast for China growth in 2016 is 6.5 per cent, Tao says long-term trend growth beyond the current cycle will be more like 4 to 5 per cent. This still outstrips the growth in any other Organisation for Economic Co-Operation and Development (OECD) country but dwarfs China's more recent explosive growth.

Nobody heeded the warning

The thing that really gets on Tao's goat is that he has been saying the same thing for three years but many in the resources sector didn't listen.

In his March 2012 report, he warned China's golden age of infrastructure investment, housing boom, export and policy stimulus had already ended. At the time he said China's growth trend would slow to 7 to 8 per cent in the coming decade.

Illustration: David Rowe

"When people are desperate they want good news but they don't realise the entire climate is changing and the separation between the good and the bad depends very much on whether you can see the trend beyond the next data cycle," Tao says.

"This is going to be driven by consumption instead of investment. The slower growth and a shift towards a consumption-based economy will substantially reduce china's demand for commodities in a secular manner."


His comments highlight the fact that most high-cost miners failed to see the slowdown coming even though there was evidence it was brewing. While there is a plethora of data on a Bloomberg terminal to demonstrate what is happening in the present, Tao notes that the market has been notoriously bad at making predictions.

Part of the problem was failing to take into account basic human nature and social issues such as the environment. Tao points to the gloomy, overcast Hong Kong sky from Credit Suisse's 88th-floor office overlooking Hong Kong harbour, and notes the sky in Beijing and Shanghai is the same almost every day.

"If China keeps growing at 7 per cent all Chinese will die from lung cancer. This is not sustainable.

"Analysts depend on their fancy models but they don't bother to walk out and sniff around. You go to Beijing as soon as you get off the plane you smell something. Your nose is your best model."

Optimism for China's future

Despite the slowdown, Tao and other economists and China observers Chanticleer met with in Hong Kong this week are optimistic about China's ability to overcome the market's current fears around the central government's policymaking decisions.

Efforts to counter the sharp devaluation of the local currency and local sharemarket rout have had limited success, undermining confidence in China's efforts to reform its economy, while become confused with longer-term banking reform and measures to open up the country to foreign capital and investment.

Many warn of a three- to four-year period of volatility as China rides out the transition.


"I haven't lost hope on China but this is not a normal cycle and this cycle comes along with a transformation. This transformation is about shifting from investment to consumption, reducing the leverage, finding new dynamic and innovative industries, breaking the monopoly and reforming the SOEs [state-owned enterprises]. The odds of having something unexpected [happening] will be on the rise," Tao says.

IMF research shows Australia will be the worst-hit advanced economy from slowing Chinese investment growth, but there are still huge opportunities for trade, tourism, agriculture and other niche businesses.

The debate around whether the world's fastest-growing economy is heading for a boom or a recession has intensified since the country's sharemarket crash last month.

This is delaying, but not killing off, efforts to move to a more market-based economy and allowing the private sector to do more investing, while sending mixed messages to the world about the central government's ability to prevent capital outflows and further weakening of the yuan.

"There seems to be a backtrack on the reform process. As soon as you get volatility they step back and want stability. You can't have both," BlackRock's head of Asian equities Andrew Swan says. He says China should be viewed as a two-speed economy going through a transition phase, which meant its old industrial-based sectors were suffering.

"There is real pain in that sector and we are starting to see signs of unemployment starting to rise and bad debt starting to rise. But if you look at the industries they are trying to develop they are performing very strongly."

Transition may cause upheaval

The rationale for long-term economic reform has not gone away. ANZ's Li-Gang Liu says the country's relatively low central government and household debt, means there is little risk of balance-sheet recession.


Liu, who says he is somewhere in the middle of the bulls versus bears debate, says China will experience further volatility and policy upheaval as it goes through a transition to a consumer-led economy.

"This transition is not going to be easy at all and we have seen that so far this year. We have seen the market rout and the rescue is failing. The sudden devaluation of the exchange rate surprised many. The growth rates is moving quite below 7 per cent and suggesting that the government is no longer as effective. All this has made investors and corporates quite worried about China," he says.

While Liu says China has not finished its urbanisation, the shift to a consumer-led economy will not help the miners trying to sell resources into China. That story is over and the next wave of opportunities for Australian companies will come in niche products such as vitamins, agriculture, and tourism.

Credit Suisse's Tao illustrates the changing social demographics in China with an anecdote about a young Chinese man spending 36 yuan ($7.90) on a cup of coffee.

"My father would never buy a cup of coffee for 36 yuan, that's why he has a 50 per cent savings rate. For the younger generation, the savings rate is zero. It is hard to imagine why the Chinese could do that when China does not have a social safety net. Their safety net is their parents," he says.

"We are seeing a new consumer army joining and they are the American consumers with the Chinese passport. This is why I feel confident that beyond this cycle China will bounce back."

Watered-down benefits

Despite all the back-slapping and the obvious benefits to parts of the Australian economy, the exclusion of China from the Trans-Pacific Partnership (TPP) waters down the value of the world's largest trade agreement in decades. It is not surprising given the United States' efforts to flex its muscles in a region increasingly dominated by China.


Australian and New Zealand officials who were key drivers of the initial TPP initiative are said to be frustrated at the outcome of the trade negotiations which became more about the United States' relationship with Japan than anything else. New Zealand dairy giant Fonterra warns of "entrenched protectionism" from the United States a deal which failed in its original goal to eliminate all tariffs.

The main game for many in the region in terms of trade is now the Free Trade Area of the Asia-Pacific (FTAAP) regional trade agreement, currently under negotiation.

Still, the benefits of the TPP to Australian companies and investment should not be underestimated and there was no shortage of business groups embracing the potential benefits from the deal. This is good timing for the Turnbull government keen to demonstrate its credentials as a strong economic manager.

Michael.Smith@fairfaxmedia.com.au

Twitter @MikeSmithAFR

Tony Boyd is on leave