Opportunities in smallcaps header image 2

The Holland of Asia

March 4th, 2010 · No Comments

Turns out to be a remote part of China. But the lessons are more general…
Bubble in Shangri-La?
Patrick Chovanec

Last week, when I was traveling, Geoff Dyer had an excellent article in the Financial Times on the sustainability of China’s investment boom. It’s chock full of good data points and presents a very balanced view of the issue. Now that I’m back in Beijing, I wanted to highlight it and offer a little bit of additional perspective.

The article focuses on a town called Chenggong, on the outskirts of Kunming (the capital of Yunnan province), as an example of what may or may not be wasteful “overbuilding.” As is so often the case with stories “plucked from the middle of China,” it can be hard for readers who aren’t overly familiar with the place and context to fit this snapshot within a larger picture of China. To what extent is Chenggong an outlier, or typical of trends seen elsewhere? It so happens that I’ve spent some time in Chenggong, so I might be able to help out a little here.

Yunnan province lies in the far southwest of China, along its mountainous border with Myanmar (Burma), Laos, and Vietnam. It’s part of the region I call (in my Atlantic article on “The Nine Nations of China”) Shangri-La. Its rugged landscape is known for its scenic beauty, unspoiled climate, and rich biodiversity. But Shangri-La is also the poorest region of China, due to its treacherous terrain and limited infrastructure. Minority hill tribes account for about 1/3 of the region’s population. Although Kunming and its suburbs (including Chenggong) are almost entirely settled by Han Chinese, they retain a somewhat remote and exotic air.

Chenggong itself was, until recently, a largely rural county located just to the southeast of Kunming, along the eastern shore of a large lake. At an elevation of 2,000 meters (more than a mile high), just a few miles north of the tropics, the climate tends to be clear and mild. This pleasant climate accounts for the two things for which Chenggong is famous, which the FT article didn’t mention. First, it is home to a year-round training center for China’s Olympic athletes. Second, Chenggong is focal point of a rapidly growing trade in cut flowers, which are cultivated by local farmers and exported all across Asia. Dubbed “Holland in Asia,” the town hosts a formal auction floor modeled on the Dutch flower exchange in Aalsmeer, with nearly a million stems changing hands every day. It was a visit to this flower market that brought me to Chenggong a little over a year ago.

With this backdrop in mind, it’s possible to evaluate the true takeaways from last week’s FT article.

On the negative side, one of the things that most struck me was the account of empty residential units and the stockpiling of multiple units by speculators, a phenomenon I’ve pointed to many times before, and which formed the basis for one of Geoff’s earlier columns. A sidebar to the main article relates:

At one of the town’s many estate agents, a Mr Xin is eyeing up new apartments . . . he already owns eight flats at a compound called Huilan Yuan, which had in theory been set aside for civil servants moving to the town, but he is interested in more. “I think it is a good idea to invest now before the property prices in Chenggong start to rocket,” says Mr Xin.

Many real estate “bulls” in China will admit that stockpiling exists, but contend it is restricted to Beijing and Shanghai, which serve as magnets for wealth from all over the country. In second and third-tier cities, they argue, people are buying places to live, and the growth is sustainable. Putting statistics aside, just on the basis of what I’ve observed traveling around China, I’ve always been reluctant to credit this argument. I’ve seen plenty of places in the provinces, in second, third, or even fourth-tier cities like Ordos (in Inner Mongolia) and now Chenggong (in the remote southwest) where people – for better or worse — appear to be investing in residential real estate, not to live in, but as a store of wealth. If there’s an overhang in the residential real estate sector, it is happening across China, and is not confined to Beijing and Shanghai.

On the other hand, the article also highlighted several infrastructure projects in the area that I see as far more productive:

. . . a high-speed rail line will connect Kunming to Shanghai, nearly 2,000km away, and help bind this once isolated region more closely into the national economy . . . The investment boom is also intended to reorient the region’s economy, which has long focused on China’s richer east coast, towards its south-east Asian neighbours. The construction of a bridge has completed a road linking Kunming to Bangkok, while a bridge on another road joining Yunnan with northern Vietnam is nearly finished. Road and rail links to the border with Burma are also being improved and a Rmb23bn airport is under development, with the aim of making Kunming a hub for tourism in south-east Asia.

As I’ve said before, there are parts of China where expanded infrastructure is desperately needed, and other parts that are grossly overbuilt. This is one region where it is desperately needed. One of the main reasons Shangri-La is the poorest of China’s “nine nations” is its inaccessible terrain and lack of links with the outside world. In the past few years, crossborder trade with ASEAN has been booming, and improved road and rail links will only help. And upgrading Kunming’s airport will not only bring in more tourists (to what is already a thriving tourist hub), but could help overnight shipments of Chenggong’s cut flowers reach wider markets all over the world.

The point is, it’s hard to generalize about China’s investment boom. The bulls and bears cited in the article are both correct, in a sense, and who is more correct depends on where in China you’re looking at. Is there a bubble in Shangri-La? In housing, there are worrying signs that the frothy exuberance that might make more sense in Beijing or Shanghai can be found in more remote corners of China. In infrastructure, the same kind of projects that might transform a place like Kunming or Chenggong, by connecting them to rapidly growing markets for what they already have to offer, could be monuments to pointless excess somewhere else. What I worry about, though, given that investment made up 50% of GDP last year, is that there are plenty of such “monuments” being built where they make no sense, just to hit growth targets. As Bill Adams of the Conference Board is quoted in the article as saying, “There is so little transparency, so little visibility – that is what is worrying about the investment boom.”

It’s not a simple picture — but then, China’s not a simple country. That’s one reason I find the “Nine Nations of China” framework useful in drilling down to the truth.

Tags: China