Dear ReaderFew would have predicted the tumultuous events of the past twelvemonths across political, economic and financial spheres. Amidstthe challenges and opportunities facing us all, Asia has remainedthe bedrock of growth and prosperity. With this in mind, we againdedicate the 2012 Julius Baer Wealth Report to our second homemarket, Asia, re-examining in closer detail which key economies inthe region are on the frontier of wealth creation. We pay particularattention to China, India and Indonesia, given the unique role andcombined size of these three economic giants in Asia. Overall, wefind that the region’s strong economic fundamentals leave it in poleposition to drive global wealth creation through 2015.The second Julius Baer Wealth Report also marks the next instal-ment of our Lifestyle Index, which tracks the cost of living for highnet worth individuals in Asia. The results thereof reinforce theneed for providing sound and innovative long-term investment adviceand planning: a key focus point that we address in the 2012 reportas well. As we look forward to the medium term and expect theworld to continue to change at a rapid pace, we reaffirm our deepcommitment to being long-term partners in wealth management.I trust you will find the 2012 Julius Baer Wealth Report on Asia asinsightful a guide as our inaugural effort.Boris F. J. CollardiChief Executive OfficerPresident of the Executive BoardJulius Baer Group 1
Introduction: 4 Why Asia matters even more Wealth creation revisited:10 Becoming wealthy in a more difficult world China, India, Indonesia:16 Frontiers of growth China, India, Indonesia:34 Profiles in business excellence 2012 Julius Baer Lifestyle Index:41 The cost of luxurious living Investment philosophy:46 Success means becoming and staying wealthy Wealth planning:54 Life can get very complicated Conclusion:57 Where do we go from here?
IntroductionWhy Asia matterseven moreSince the inaugural Julius Baer WealthReport was published in August 2011,the eurozone crisis has moved fromchapter to chapter. Global growthprospects have once again dimmed,and the allure of safety in financialmarkets pushed US Treasuries andGerman Bunds to exceptionally lowyields. Greece carried out the largestsovereign debt restructuring in history– to date – staving off economic ruin,at least for the time being.
Most developed economies face serious fiscal and estimates. Put succinctly, uncertainty remains high,debt challenges owing to demographic trends, well structural headwinds persist and hence the outlookbeyond the immediate crises that have dominated for significant wealth creation in developed econo-the eurozone. At the same time, the collapse in mies is difficult, to say the least. Against thishouse prices since 2007 means that the median back rop, we again dedicate the second Julius Baer dhousehold’s real net worth in the United States Wealth Report to our second home market, Asia.has fallen to the 1995 level, according to someChart 1Contribution to global GDP growth: Asia in pole position –3% – 2% – 1% 0% 1% 2% 3% 4% 5% 0.05 0.392008 +2.5% -0.07 1.21 0.91 –0.66 0.502009 –0.59% –1.15 –0.56 1.28 0.30 0.502010 +5.1% 0.64 1.53 2.14 0.23 0.432011 +3.8% 0.36 1.42 1.36 -0.04 0.412012F +3.3% 0.43 1.26 1.24 0.15 0.492013F +4.0% 0.45 1.48 1.44 United States Eurozone China India Rest Source: Datastream, Julius Baer 6
Chart 2 Julius Baer Deflation Indices: Developed economies face the threat of falling prices18 %16 %14 %12 %10 % 8 % 6 % 4 % 2 % 0 % F A J A O D F A J A O D F A J A O D F A J A O D F A J 2008 2009 2010 2011 2012 United States Eurozone Japan Switzerland Source: Datastream, Julius Baer The key exercise in the second Julius Baer Wealth The Julius Baer Lifestyle Index speaks volumes about Report is to stress-test the assumptions and con the realities that Asia’s high net worth individuals clusions of the inaugural effort. The world has not face when it comes to covering their cost of living. At changed for the better in the intervening period; the same time, it also demonstrates a key difference therefore the re-examination of our outlook is prudent. between Asia and developed economies outside the Secondly, closer attention is paid to the economies region. Namely, structurally higher inflation pressures in Asia that are on the frontiers of wealth creation, can be found in Asia compared to deflation fears namely China, India and Indonesia. To gain valuable that tend to grip developed economies as shown above. insights into the economic transformations that The latter carries the risk of slipping into a Japanese- underpin the creation of wealth, we have interviewed style malaise, especially given that the deleveraging key business leaders whose own operations give process has yet to start in earnest in Europe and them a unique vantage point into that process. We arguably still has some room to run in the United States. proceed by detailing the next instalment of the Julius Baer Lifestyle Index, a proprietary indicator that measures the changes in the cost of living for Asia’s high net worth individuals (HNWI). Lastly, we consider essential concepts in preserving and managing wealth over the longer term. 7
Chart 3Inflation over the longer term35 %30 %25 %20 %15 %10 % 5 % 0 %–5 % 1970 1975 1980 1985 1990 Advanced economies Developing Asia Forecast Source: Datastream, Julius BaerAgainst stagnant or only moderately growing G3 Beyond conventional drivers of economic growth,(the USA, the UK and Japan) economies, we find China has shown its commitment to financial sectorthat Asia matters to the global economy more than reform as well. For example, the June decision by theever. The summer of 2012 has seen global growth Hong Kong Monetary Authority to bolster the li uidty q iforecasts suffer downgrades across the board – but of the offshore renminbi (CNH) market and thethe relative lead of Asia has remained unchanged. People’s Bank of China’s move to liberalise interestIndeed, looking to 2013, we forecast that China and rates are major steps. In other words, as the euro-India will again deliver half of the world’s overall zone has struggled to regain institutional coherence,growth, as has been the case since 2011. This is ring-fence weaker states and contain the risk ofwithout China resorting to powerful monetary bank runs, China has pressed ahead with importantor fiscal stimulus packages as was the case in 2008. measures that build the base upon which futureGiven the deepening linkages between emerging growth can emerge. This leads us to conclude thatmarkets, China’s growth in particular has far- Asia, and China especially, is becoming ever morereaching implications across Asia and beyond. important for growth and wealth creation. One of the main risks to Asia’s shorter-term growth prospects remain contagion effects from the eurozone crisis, but all indications so far are that regional policy- makers have the tools at their disposal to mitigate the worst effects. 8
Wealth creation revisitedBecomingwealthy in a moredifficult worldIn the year after the inauguralJulius Baer Wealth Report, globalgrowth concerns resurfaced as theeurozone crisis entered into itssecond year. The process to addressthe institutional shortcomings thatinitiated the crisis has been slow ascompeting political and economicinterests prevented a workableconsensus from forming quickly. 10
Chart 4Asian credit default swap (CDS) correlations to Europe have fallen600 1 basis points correlation500 0.8 0.6400 0.4300 0.2200 0100 -0.2 0 -0.4 2006 2007 2008 2009 2010 2011 2012 Average CDS: China, S. Korea, Indonesia, Malaysia, Hong Kong 12-month rolling correlation (r.h.s.) Average CDS: France, Italy, Spain Source: Datastream, Julius BaerIn the midst of the crisis, measures to reduce the Yet the economic outlook for Asia remains compasystemic risks in the European banking system by ratively robust, according to the Internationalraising capital requirements aggravated the decline Monetary Fund’s (IMF) July assessment. It is clear,in credit extension. Despite extensive efforts by however, that Asia cannot remain immune to weakcentral bankers to avert a credit crunch via liquidity economic activity in Europe indefinitely. The trans-provision measures, the combination of these fac- mission mechanism of the eurozone crisis workstors has left much of Europe with an anaemic GDP along three basic paths: financial markets, exportgrowth outlook over the coming years. While the demand and credit extension. On the first avenue,growth outlook in the United States is relatively san- the degree to which financial market contagion hasguine, structural headwinds such as the impending weighed upon Asia is debatable. For one, the countryfiscal consolidation and still weak labour and housing risk premium of Asian sovereign issuers decoupledmarkets have sustained a growth path that is below from the eurozone, as measured by the rolling cor-its previous potential. relation between the two. This idea is captured by the observation that as the European country riskChart 5Asia’s sovereign credit ratings have held their ground while Europe has faltered 2008 2012AAA ESPAA+AA PRT CHNAA- ITAA+ GRCA MAS MASA- CHN THA ESPBBB+ THA ITABBBBBB- INABB+ PRTBBBB-B+ INABB-CCC+ GRCCCCCCC-CCCD Source: Datastream, Julius Baer 11
rises (using an average of country risk from France, it is difficult to say that Asia has suffered inordinateItaly and Spain), the correlation to Asia falls. Indeed, levels of financial market contagion due to the euro-the sovereign credit rating of Asian issuers has zone crisis. On the trade demand side, there hasremained largely stable while the eurozone has been been evidence of weak eurozone consumption forhit with a series of sharp downgrades. On the other much of 2012. In part, sluggish eurozone demandhand, in terms of equity markets, the per ormance of f has been compensated for by better conditions inAsian stocks has on average not been markedly the United States. Also the rise in intra-emergingd ifferent from global peers for most of 2012. Hence markets trade has diminished the role of EuropeanChart 6Exports of goods to the eurozone by region60% 49.93 49.47 48.0250% 32.9340%30% 19.89 16.72 15.91 13.26 12.62 13.220% 11.18 10.72 7.53 8.8 6.67 5.84 3.8110% 1.99 1.98 1.13 0% Euro area Emerging Other Common- Middle East Sub-Saharan Developing Latin Advanced USA and Europe advanced wealth of North Africa Africa Asia America Asia Canada Europe Independent States Share of region’s GDP Share of region’s exports Source: IMF, Julius BaerChart 7Exposure to eurozone banks, via claims such as deposits50% 47.17 % of GDP45% 38.7640%35%30%25%20%15% 11.44 11.1110% 8.06 6.98 6.28 5.53 5% 1.76 0% Other Emerging USA and Latin Common- Middle East Advanced Sub-Saharan Developing advanced Europe Canada America wealth of North Africa Asia Africa Asia Europe Independent States Source: IMF, Julius Baer 12
demand, but it remains difficult to conclusively dis- Against this backdrop, we re-examine the conclu-aggregate what is end demand in emerging markets sions reached in the first Julius Baer Wealth Reportversus demand that is linked to intermediate stages on Asia. In 2011’s report, we found that the combina-in production for re-export to developed economies. tion of currency appreciation, GDP growth, stockAs a percentage of Asia’s GDP however, manufactur- market and property returns would propel Asia’s highing exports to Europe are relatively small – which net worth population (in US dollar terms) fromshould limit the downside. In terms of exports, the 1.16 million in 2010 to over 2.8 million in 2015. Chinaeurozone itself and emerging European countries would capture almost half of the region’s increaseremain substantially more at risk given the crisis. in high net worth individuals by having 1.37 million individuals in this category. On a growth rate basis,The third transmission mechanism is Asia’s exposure Indonesia was forecast to be ahead of even China,to European banks in terms of credit. In this area, tripling the number of wealthy individuals to 99 thou-high-level statistics suggest that impact should be sand by 2015. The combined stock of wealth oflimited because eurozone banks’ lending as a per- Asia’s high net worth individuals would surge fromcentage of Asian GDP is small. However, this only USD 5.6 trillion to almost USD 16 trillion overcaptures part of the story. Arguably, more important these five years. Once again, China would representis the question of trade finance for export transac- almost half of this wealth increase.tions. Data from the first quarter of 2012 showsa significant drop-off in Asian syndicated trade Of the assumptions made in the model, the sensitifinance. According to Morgan Stanley, this can be vity of the currency changes used has the highestexplained by curtailed lending by French banks, impact in terms of final outcomes. Indeed, under thewhich has in part been compensated for by an in- original model, the weaker dollar over the forecastcrease in trade finance issued by Japanese banks. period resulted in an additional 600 thousand high netNevertheless, the risk of a drop-off in trade finance worth individuals for Asia as a whole. The reasonis serious given the immediate impact it would is that currency moves instantly revalue the accumu-have on production. What negates this risk to some lated wealth stock, whereas the other variablesextent is that Asia’s government finances are add to wealth but do not influence the value of pastin good health – this means that fiscal resources wealth. In order of influence, currency appreciation iscould fill in where market resources fail in the followed by nominal GDP growth, property and stockshorter term. markets.Chart 8Asia-based trade finance dropped off in 2012 as the eurozone crisis escalated10 9.3 USD billions 9.098 7.3 6.9 6.7 6.97 6.66 5.3 5.1 4.95 4.4 4.6 4.5 4.5 4.2 4.04 3.4 3.1 2.7 2.53 2.0210 2007 2008 2009 2010 2011 2012 Source: Morgan Stanley, Dealogic, Julius Baer 13
Our approach in the 2012 Wealth Report is to use the and nominal GDP over the medium term. Hence, for outcomes published last year as a baseline scenario three of the four variables, we see little cause to and model ‘upside’ and ‘downside’ variations around make dramatic changes to the underlying method the centre. The reasoning is as follows: With resilient ology. However, we recognise that economic cycles domestic economies, Asia has become less exposed have become shorter in duration and the unpreced to cyclical swings in export demand, therefore ented nature of recent events troubling the eurozone we do not expect a major deviation from the original means that uncertainty remains high. These two assumptions on nominal GDP growth. Structural factors combined warrant a prudent approach that demand for property in Asia should remain robust takes into account ‘downside’ to our baseline scenario. and stock markets should parallel earnings growth Chart 9 Chart 10 Number of HNWI Wealth stock of HNWI1,500 1,400 1,300 500 400 300 200 100 0 0 500 1,000 1,500 1,460 9,300 1,378 1,275 China 8,764 8,107 502 2,627 420 2,581 403 384 India 2,465 2,331 173 949 302 1122 310 322 South Korea 1074 1040 138 412 134 728 131 128 Hong Kong 711 693 86 484 141 615 136 130 Taiwan 593 564 70 269 133 636 129 123 Singapore 616 587 64 312 136 647 128 118 Thailand 609 560 47 214 104 518 99 87 Indonesia 487 408 33 129 71 347 68 64 Malaysia 329 307 32 143 39 172 38 35 Philippines 164 152 16 60 2015 upside 2015 baseline 2015 downside 2010 Source: CLSA, Julius Baer 14
To model our ‘downside’ scenario, we shaved off 10% Korea experiencing the largest population growth from all four inputs: nominal GDP growth, currency through 2015. The least sensitive to the revised appreciation, property and stock market returns. The assumptions in the downside scenario is Hong Kong, cumulative impact of these changes results in a 2015 as we assume that the existing pegged arrangement population of high net worth individuals of 2.6 million of the Hong Kong dollar will remain intact over the or 174 thousand fewer than in the baseline scenario. forecast period. As a result, Hong Kong’s modelled The 2015 stock of wealth under the downside scen rioa outcome is the consequence of three, not four, declines to USD 14.75 trillion, or just over one variables. trillion dollars less than the baseline. The population ranking is unchanged, with China, India and South2,500 3,000 3,500 4,000 4,500 5,000 5,500 6,000 6,500 7,000 7,500 8,000 8,500 9,000 9,500 10,000 USD billions To complement our downside scenario, we have Given the resilience of Asia so far in spite of the added 10% across three variables under the upside worsening external backdrop, we expect to see an outcome. This captures the idea that sentiment outcome that lies between the baseline scenario and economic activity may be inordinately depressed and the upside outcome. Unlike the United States, in the midst of the eurozone crisis, but then bounce Europe and Japan, Asia’s economies still have ample back over the forecasted horizon. In a bid to prevent fiscal room to manoeuvre which therefore limits the our upside from being overly optimistic, we have negative impact of contagion. The downside scenario added only 5% to the original currency appreciation would present a greater risk, the longer the eurozone input. This approach introduces a degree of crisis persists, however, as this would magnify prudence that would have been lacking otherwise. the depth and duration of the external shock. On the Under the upside scenario, Asia will see an additional other hand, if external and financial market condi- 139 thousand high net worth individuals through tions recover faster, then the upside scenario should 2015, bringing the total to 2.96 million. The total have a higher likelihood of transpiring into reality. stock of wealth would reach USD 16.7 trillion, In any case, the bulk of the risks facing Asia’s wealth- or USD 855 billion more than under the baseline generating capacity remain exogenous to the region. scenario. Once again, China is set to dominate in terms of new high net worth individuals, followed by India and South Korea. 15
China, India, IndonesiaFrontiersof growthOf the ten Asian economies covered inthe Julius Baer Wealth Report, China,India and Indonesia emerge as the region’sgiants of wealth creation. With over halfa million individuals, China is already hometo the largest number of high net worthindividuals in our sample of countries whileIndonesia and India hold enormous promiseof catching up.
At first glance, the reasons for China, India and Thus far China’s economic model has relied heavilyIndonesia’s dominance seem deceptively simple: The on large fixed asset investments that focused oncombined adult population of these three giants is the export sector and real estate construction. With1.86 billion, or 90% of the total covered in our selected an effectively closed capital account, China has beencountries. With the exception of Indonesia during the able to drive savings into real assets owing to low or1997–1998 Asian financial crisis, all three have seen negative real interest rates. Running large externalGDP growth remain well above the global average balances has resulted in the record accumulation ofover the past 20 years. It stands to reason therefore, international reserves. The seemingly endless supplygiven the combination of rapid growth and large of rural labour moving to cities up until now meant thatp opulations, that these countries should be at the low wages kept China very competitive. India hasforefront of wealth creation in Asia. forged a different path, sustaining a large agriculture sector for a much longer period of time. ImportantAt the same time, they are very different economies reforms in the early 1990s opened the economy, butwith unique development paths. We believe that rather than leaning the focus on manufacturingChina, India and Indonesia stand at critical inflection exports, IT and business outsourcing grabbed thepoints in terms of their growth models, and what spotlight. Indonesia’s economy is relatively diversified,has worked in the past may not generate growth and with the credit cycle having played a larger role thanprosperity in the future. In this section we examine in China and India. At its core, however, the economyin detail their economic models and what the future still has significant exposure to commodities, bothholds for wealth creation in these Asian giants. energy and non-energy.Chart 11Employment by sector 26.5% 34% 42.4% 22.4% 29% 19.3% 51.1% 37% 38.3% China India Indonesia Services Industry Agriculture Source: Datastream, Julius Baer 17
The central theme that unites China’s economic policy- Chart 12making framework is ‘rebalancing’. As outlined in China – Population vs. GDPthe current Five-Year Plan, China must adopt a moreconsumption-oriented model and narrow the incomegap that has arisen as a consequence of the coastalregions’ dominance in the global manufacturing exportmarket. Hence ‘rebalancing’ seeks to raise the standardof living not just across income groups but acrossgeographic regions as well. Is China achieving its goalsof generating prosperity in the central and westernprovinces? To put it in a nutshell, yes. Xinjiang 1 Province GDP per capita (USD) Population (million) 2011 inflation (%) 1 Xinjiang 4,567 22.1 5.9 2 Tibet 3,108 3.0 5.0 3 Qinghai 4,473 5.7 6.1 4 Gansu 3,022 25.6 5.9 5 Ningxia 5,015 6.4 6.3 6 Sichuan 4,046 80.5 5.3 7 Yunnan 2,935 46.3 4.9 8 Guizhou 2,541 34.7 5.1 9 Chongqing 5,342 29.2 5.3 Tibet 2 10 Shaanxi 5,131 37.4 5.7 11 Shanxi 4,796 37.4 5.2 12 Henan 4,487 93.9 5.6 13 Hubei 5,284 57.6 5.8 14 Hunan 4,618 66.0 5.5 15 Guangxi 3,919 46.5 5.9 16 Hainan 4,459 8.8 6.1 17 Guangdong 7,787 105.1 5.3 18 Fujian 7,273 37.2 5.3 19 Jiangxi 4,008 44.9 5.2 20 Zhejiang 9,083 54.6 5.4 21 Anhui 3,923 59.7 5.6 22 Shanghai 12,783 23.5 5.2 23 Jiangsu 9,545 79.0 5.3 24 Shandong 7,317 96.4 5.0 25 Hebei 5,198 72.4 5.7 26 Tianjin 13,058 13.6 4.9 27 Beijing 12,447 20.2 5.6 28 Inner Mongolia 8,905 24.8 13.7 29 Liaoning 7,788 43.8 5.2 30 Jilin 5,933 27.5 5.2 31 Heilongjiang 5,050 38.3 5.8 18
Chart 13China’s GDP per capita by region50 CNY thousands40302010 0 1987 1992 1997 2002 2007 2012 East Central West Source: JP Morgan, Julius BaerChart 14Central government subsidies and transfers to regions16% % of GDP14%12%10%8%6%4%2%0% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 East Central West Source: JP Morgan, Julius BaerChina’s government has made a concerted effort to the average minimum wages across the threepull economic activity from the coastal provinces regions has narrowed sharply. In 2005, the minimumto the central and western parts of the country. This wage in the far westerly Xinjiang province wasis evident from the share of fixed asset investment CNY 300 per month, among the lowest in China. Asthat the interior of China has attracted as well as from of 2011, it has equalled Beijing’s. Whether raisingdirect fiscal transfers. Western China receives minimum wages will result in higher employment andsubsidies and transfers equal to almost 14% of GDP, actual realised incomes is a matter of debate –four times as much as the higher-income eastern but as a proxy for regional distribution of incomes, itprovinces. In terms of wage policy, the gap between appears safe to say that the gaps are closing. 20
Chart 15Minimum wage in CNY per month 1,118 1,045 909 440 338 336 East Central West 2005 2011 Source: Credit Suisse, Julius BaerIt is safe to say that incomes in cities are generally This bodes well for increases in income, all elsehigher than in rural areas. This is the primary motiva- being equal. The interesting reality is that ‘all is nottion that drives urbanisation, i.e. the movement away equal’ in practice. Put differently, the link betweenfrom agriculture into higher value-added manufactur- income growth and rising urbanisation is not guaran-ing and services. As it stands today, approximately teed. At lower levels of urbanisation, per capita47% of China, 44% of Indonesia and 30% of India’s incomes tend to be clustered. However, as urbanisa-population is urbanised. Of the world’s total popula- tion rates grow, the distribution of incomes tendstion, the United Nations (UN) estimates that around to increase as well. Hence, something can stillhalf of all individuals live in cities, and this is expected ‘go wrong’ when the countries are evolving towardsto reach 69% by 2050. That said, countries are ever larger cities. Understanding how to avoid suchforecast to show differing rates of compound annual outcomes is critical for China, India and Indonesia,growth rates of urbanisation. China, India and especially given their still relatively low urbanisationIndonesia are among the fastest to show urbanisation, rates, which tells us that at least on this score, thereaccording to the UN. is much to gain or lose.Chart 16Urban population versus GDP per capita purchasing power parity (PPP) (2010)50,000 US dollars USA45,00040,000 CAN DEU35,000 JPN FRA GBR30,000 ITA KOR25,000 CZE KSA20,000 POL HUN MAS MEX ARG15,000 CHI RUS RSA TUR PER BRA10,000 THA COL CHN IND EGY 5,000 KEN BAN MAR INA PAK NGR 0 20% 30% 40% 50% 60% 70% 80% 90% 100% Source: Credit Suisse, Julius Baer 22
Amongst China, India and Indonesia, India’s economic wide basis, India has been enjoying a structurallygrowth trajectory is arguably, for the lack of a better higher per capita income expansion rate – perhapsphrase, the most elusive to understand. In the cen- even the fastest in modern history.tury prior to independence in 1947, India’s per capitaGDP grew by merely one per cent per year. Post- But has India shown similar convergence as Chinaindependence, under the largely closed, centrally has witnessed in terms of addressing regionalplanned model through to the end of the 1980s, income discrepancies? In short, no. Neverthelessgrowth did not fare much better. Indeed, during the there is good and bad news. First, the good news1980s, China and India had very similar per capita is that comparing the periods 1993–2001 and 2001–GDPs (USD 300) and lagged behind Indonesia’s USD 2009, research shows that all 21 of India’s most popu600 per capita income. The key turning point is gen lous states grew faster in the latter period relativeerally acknowledged to be 1991 after which economic to the former. Some states, namely Uttarakhand,reforms saw growth rates triple. That said, taking Maharashtra, Chhattisgarh and Gujarat, showed1991 as a base year, China’s per capita income has dramatic increases in their GDP growth rates. Thegrown at a compounded annual rate of 14% through bad news is that initial starting levels of per capita2011, compared to 7% for India and 8% for Indonesia. income seem to have a significant bearing on theIndia’s per capita GDP really took off in 2002, tripling outcome. In other words, the states with higher perfrom the USD 480 then to the current USD 1,500. capita income tended to grow faster than lower-Over the past decade, income per head has grown at income peers, thereby limiting the convergencea compounded 11%, clearly catching up with China’s between the two.growth rates. This tells us that at least on a nation-Chart 17Growth rates of net domestic GDP per capita across Indian states10% Change in growth rate, 2001 – 20099% Uttarakhand Maharashtra Gujarat8% Delhi Kerala7% Haryana Orissa Tamil Nadu Andra Pradesh6% Chhattisgarh Bihar Karnataka5% Jharkand Punjab Himachal Pradesh West Bengal Uttar Pradesh4% Madhya Pradesh Rajasthan Assam3% Jammu & Kashmir2%1% Change in growth rate, 1993–20010% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Source: India office of Central Statistics, Utsav Kumar and Arvind Subramanian, Julius BaerThe explanation for India’s lack of state-level con- manufacturing and business services. However, thisvergence is challenging. A typical line of argument is has proven to be a double-edged sword as during theto test whether openness to international trade and crisis years of 2007–2009, these states also sufferedmanufacturing is the key to sustainably higher income the largest GDP growth slowdowns. On the othergrowth rates. Gujarat, Karnataka (home of IT and hand, Kerala, with a very low exposure to manufacbusiness outsourcing powerhouse Hyderabad), and turing (less than 10% of GDP), has consistently enjoyedMaharashtra have indeed shown above-average above average-growth rates since 1993 and felt verygrowth rates and also have the highest share of little of the 2007–2009 crisis. 23
Perhaps another explanation of India’s growth Indian males in rural communities have left farmingconundrum lies in classification issues. ‘Rural’ need and went into industry and services, but not moved tonot imply agriculture, as recent research highlights. cities. This trend is arguably unique in the emergingAs infrastructure spending (i.e. roads, electrification) markets and may be India’s ‘best kept secret’ inupgrades the productive capacity of India’s rural terms of how wealth will be created in future: Not inenvironment, individuals outside of cities are switch- Mumbai, Delhi or Bangalore, but the next wave ofing to manufacturing but stay put in terms of their millionaires may hail from newly industrialised hubsphysical location. Over the past decade, 150 million in the countryside.Chart 18Indian rural employment trends: Shifting out of agriculture900 Thousands per employed800700600500400300200100 0 1978 1983 1988 1994 2000 2005 2010 Industry Services Agriculture Source: Credit Suisse, Julius Baer 24
Turning to demographics, it is by now well under- presents an economy with a powerful force ofstood that among China, India and Indonesia, China producers, consumers and savers that lay thehas entered the much maligned ‘ageing’ phase foundation for rising standards of living and wealthand hopes are high for the demographic dividend to accumulation. On a national level, India has theaccrue to Indonesia and India. Some caution is clear lead with a working-age population that is setwarranted here. Why is so much attention paid to the to peak only in 2050, whereas the same point wasbenefits of the demographic dividend? The reason reached in China in 2010. However, national statisticsis simple. To quote Utsav Kumar and Arvind Subrama- often disguise important regional differences that,nian, “demographics affect growth because different when examined more closely, may confound theage groups exhibit different economic behaviour”. c onclusions reached based on the country-level data.Hence, a large and growing working-age populationChart 19Demographic dividend – Working-age population (15–64 years)1,400 Millions1,2001,000 800 600 400 200 0 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 China India Indonesia Forecast Source: United Nations, Julius Baer
For this reason, before a priori assuming that demo- exogenous or endogenous – and overruled the graphics will become a drag on growth for China, beneficial demographic profile. Secondly, the data a closer look at India’s state-level data is useful. For suggests that across India, the demographic divi- one, the bulk of the increase in India’s working-age dend was higher over the period 1991–2001 (the first population has centred on Bihar, Madhya Pradesh, decade of major reforms) than over 2001–2009, Rajasthan and Uttar Pradesh. The economic perform where the coefficient, surprisingly, is even negative. ance of these states is mixed, at best, when com- pared to average growth rates over time. It is not This again challenges the notion that by virtue of possible to deduce that there is an unambiguous having a growing working-age population, economic boost to income per capita given working-age popu- outperformance is guaranteed. So is a vanishing lation increases per se. Other factors must have demographic dividend going to present an insur- been at work that were a drag on growth – either mountable challenge for China? We disagree. GDP Population 2011 GDP Population 2011 Province per capita (USD) (million) Inflation (%) Province per capita (USD) (million) Inflation (%) 1 Jammu & Kashmir 1,029 11.7 10.1 17 Andhra Pradesh 1,529 84.4 5.9 2 Himachal Pradesh 1,772 6.8 6.1 18 Tamil Nadu 1,783 67.3 8.2 3 Chandigarh 3,198 1.4 9.8 19 Jharkhand 747 31.3 6.3 4 Punjab 1,731 29.0 6.4 20 Bihar 491 97.2 7.3 5 Haryana 2,291 25.3 6.8 21 Orissa 1,026 41.7 4.6 6 Delhi 3,488 16.6 8.7 22 Chhattisgarh 1,031 25.0 5.1 7 Rajasthan 1,053 67.4 8.9 23 Sikkim 2,034 0.6 5.5 8 Gujarat 1,916 58.7 9.2 24 West Bengal 1,165 89.2 6.9 9 Maharashtra 2,014 112.0 8.0 25 Assam 750 30.4 9.3 10 Goa 4,504 1.7 7.3 26 Arunachal Pradesh 1,319 1.4 8.6 11 Karnataka 1,501 59.2 9.8 7 Nagaland 2 1,242 2.0 7.012 Puducherry 2,431 1.2 7.4 28 Manipur 727 2.8 7.613 Kerala 1,762 34.5 7.5 29 Mizoram 1,172 1.1 7.114 Uttarakhand 1,674 9.9 8.8 30 Tripura 1,059 3.6 6.415 Uttar Pradesh 654 199.3 7.6 31 Meghalaya 1,272 2.6 18.316 Madhya Pradesh 794 71.7 9.0 32 Andaman and 1,834 0.5 9.0 Nicobar Islands Source: UBS Investment Bank, World Bank, CEIC, Julius Baer 27
The ‘one-child policy’ was launched in 1979, setting targeting low value-added exports, but a revolutioninto motion the inevitable path towards an ageing in productivity that underwrites higher wages andsociety as the overall birth rate in China fell and positive real returns on capital.mortality rates stayed more or less stable. China’sdemographic trend is as predictable as the United What could challenge this rather benign view onStates’ or Japan’s, since the relevant variables are China’s waning ‘first’ demographic dividend is themoving and the data is relatively easy to observe. well-known ‘life cycle hypothesis’ made famousThe main conclusion is that China can no longer rely by Franco Modigliani in the 1960s. This tells us thaton falling dependency ratios (the percentage of non- individuals smooth out their consumption overworking-age population relative to those of working their lifetime, implying that savings ratios should fallage) as an engine of economic growth. What worries as people retire. If that is the case, then theremany is that China’s demographic dividend is declin- would be little room for a ‘second dividend’.ing faster than has been the case in other economies– and with China having played such a key role in global So how should China maintain a high enough savingsgrowth in recent years, should we not all worry? rate? The overall savings rate is likely to decline, as witnessed in other economies with an ageingThe answer is that if economic and structural reforms population, like Japan. However, the corporate sectorcontinue at a healthy pace, the role of the retired contributes to savings as well, and in recent yearspopulation in China will be central to the so-called this sector has seen a substantial increase in savings.‘second demographic dividend’. This second wind The key is not so much savings per se, but it is theworks as follows: As the retired population increases returns on these savings that matter, and here theover time, current workers will be motivated to combination of reform-driven productivity increasesm aintain or augment their savings to finance a stable and urbanisation are paramount. We believe thator even rising standard of living once they retire. China is different in that even during a political tran-Those accumulated savings can or should be invested sition period like 2012–2013, the pace of structuralin capital that enables productivity growth and in reform is slower but has not halted. Further reformsturn drives higher per capita income. In other words, to the social welfare and financial system wouldthe future for China is not so much investing in real cushion the ‘life cycle hypothesis’ and enable a ‘secondestate or opening more factories in coastal regions demographic dividend’ to kick in.
The ultimate method by which China, India and In part, China has led the way in terms of FDIIndonesia will build up their incomes per capita and thanks to economic reforms that served to make itultimately drive wealth creation is via moving their an attractive destination for global manufacturingeconomies up the value chain. This is a concept that industries. Six years ago it would take an entrepre-is often discussed but difficult to condense into neur 48 days and 13.6 times average income persimple policy choices. Producing higher-value goods capita to officially start a business in China. Today itand services (and in turn being able to demand a takes just 38 days and 3.5 times average incomehigher wage) goes beyond simple statistics such as per capita to get a company up and running, reducingeducational attainment, investment and infrastruc- time taken and start-up costs by 20% and 75%,ture. Rather, it is the confluence of a number of fac- respectively. Additionally, as a percentage of GDP pertors, extending to the social, economic and political capita, the amount of capital required to start aarrangements of a country. At the grassroots level, a b usiness today is 90% lower than in 2006. Not onlygood business operating environment represents this, but China has also eased the permission prothe most effective way that new businesses and cess to build, for example, a warehouse. Over the pastwealth can be created. One way to measure this is four years the number of days and costs associatedby considering foreign direct investment (FDI) with commercial building plans has been cut by nearlyflows, indicating how attractive a country is to inter- 10% and 48%, respectively.national investors. In general, the higher a nation’s GDP, the easier it isOver the past decade, China has attracted a large to do business there. It is probably no surprise thenamount of capital from abroad, far more than India that the World Bank ranks China as four to five yearsand Indonesia. In GDP terms, China has received ahead of India and Indonesia in its ease of doingbetween 3% and 5% of FDI. Why is this the case? business index.
That said, Indonesia is fast closing the gap. There, Despite higher volatility in its ease of doing businessGDP per capita has almost doubled over the scores, in the past four years India has also takenpast four years: Rather impressively, Indonesia has great steps in creating a more business-friendlyslashed the number of days needed to set up a environment. While home to quintuple the populationbusiness by 70%, reduced start-up costs by over of Indonesia and politically far more fragmented,82% and cut capital requirements back by more India has still managed to reduce the number of daysthan 50%. Furthermore, it is 20% quicker and 65% needed to push through start-up administration bycheaper to receive a building permit in Indonesia 60% and costs by almost 25% of average income pertoday compared to four years ago. In January 2006 capita. Transfer of property has also sped up 35%an entrepreneur could realistically expect to start taking the days needed from 67 to 44. Additionally,business operations by the summer. Now, a business registering a property in India today costs approxi-could be up and running by the end of the current mately 20% less.season.Chart 21Indonesia – Population vs. GDP West Sumatra 3 North Bangka South West Aceh Sumatra Riau Jambi Belitung Kalimantan Sulawesi 1 2 4 5 7 10 12 South Riau West East Central Sumatra Islands Kalimantan Kalimantan Sulawesi 6 8 9 11 13 Gorontalo 14 Bengkulu 19 Lampung Jakarta Central Java Central Kalimantan 20 24 25 27 South East Banten Bali South Sulawesi Sulawesi 28 30 32 21 West Java 22 East West Yogyakarta Java Nusa Tenggara East 23 26 29 Nusa Tenggara 31 30
GDP Population Province per capita (USD) (million) CPI (%)* 1 Aceh 1,898 4.5 3.3 2 North Sumatra 2,337 13.0 3.5 3 West Sumatra 1,981 4.8 5.4 4 Riau 6,810 5.5 5.1 5 Jambi 1,915 3.1 2.8 6 South Sumatra 2,331 7.5 3.8 7 Bangka Belitung 2,313 1.2 5.0 8 Riau Islands 4,694 1.7 3.3 9 West Kalimantan 1,514 4.4 4.9 10 South Kalimantan 1,777 3.6 4.0 11 East Kalimantan 9,941 3.6 6.2 12 West Sulawesi 1,044 1.2 4.9 13 Central Sulawesi 1,509 2.6 4.5NorthSulawesi 14 Gorontalo 853 1.0 4.115 15 North Sulawesi 1,786 2.3 0.7 16 North Maluku 571 1.0 4.5North 17 West Papua 3,138 0.8 3.6Maluku 18 Papua 3,475 2.8 3.416 19 Bengkulu 1,157 1.7 4.0West 20 Lampung 1,552 7.6 4.2Papua 21 Banten 1,542 10.6 2.817 22 West Java 1,970 43.1 2.8 23 Yogyakarta 1,452 3.5 3.9 24 Jakarta 9,876 9.6 4.0 25 Central Java 1,510 32.4 2.9 26 East Java 2,286 37.5 4.7 Papua 27 Central Kalimantan 2,118 2.2 5.3 18 28 Bali 1,827 3.9 3.7 29 West Nusa Tenggara 1,075 4.5 6.4 30 South Sulawesi 1,614 8.0 2.9 31 East Nusa Tenggara 651 4.7 4.3 32 South East Sulawesi 1,399 2.2 5.1 33 Maluku 580 1.5 2.8 *inflation in the capital city of the provinceMaluku33 Source: UBS Investment Bank, CEIC, Credit Suisse, Julius Baer 31
Chart 22Composite of key World Bank business operating environment metrics Starting a business 0 10 80 Trading Dealing with across borders 60 construction permits 40 20 Protecting Registering investors properties Getting credit20072012 Starting a business 0 10 Trading 80 Dealing with across borders 60 construction permits 40 20 Protecting Registering investors properties Getting credit China India Indonesia Source: World Bank, Julius Baer 32
As it stands now, China is head and shoulders above To support this argument, we have combined theIndonesia and India in terms of growth, trading ease of doing business outcomes and divided allvolumes and business friendliness, notwithstanding countries in the survey into three groups based onthe progress that India and Indonesia have made. their GDP per capita. We found that there is a closeAll three have room for further improvement, but if correlation between the two variables.recent trends continue, China, India and Indonesiacould join the upper echelons of the most business-friendly countries.Chart 23GDP per capita, purchasing power parity 45 High Income Thousands 40 Middle Income Low Income 35 China 2012 30 China 2004 25 India 2012 20 India 2004 15 Indonesia 2012 10 Indonesia 2004 5 Rank in ease of doing business 0180 160 140 120 100 80 60 40 20 0 Source: World Bank, IMF, Julius BaerIn the first group, the triangles represent high- cases, and has surely occurred to many Southincome countries that are also the easiest places to American countries, is that they are not able to godo business, such as Singapore, Hong Kong, Norway, through the invisible barrier that separates themDenmark and the United States. In the second from the developed countries. These countries aregroup, the squares, we find the middle-income suffering the ‘middle/low-income trap’.countries like China which has been ranking higherand higher, with a corresponding higher GDP per The ‘middle-income trap’ refers to countries stagnat-capita, in the past few years. ing and not evolving into advanced economies. In a steadily growing economy, the per capita GDP wouldThe third and last group accounts for all the low- rise continuously over time, towards higher incomes,income countries, among which we can still find but many middle-income countries do not follow thisIndia and Indonesia. pattern, having short periods of growth followed by periods of stagnation or even decline. In other words,Countries such as China, India and Indonesia have in most cases these countries cannot make a timelybeen improving their conditions in terms of doing transition from resource-driven growth, with low-costbusiness and their GDP per capita, but what they are labour and capital, to productivity-driven growth.risking right now is not to be able to sustain their Improving the business environment appears a goodrapid growth rate. What often happens in similar way to avoid getting stuck in the ‘middle-income trap’. 33
The future is bright for ChinaMr. Yeung Kwok Keung, founder ofChinese property development firmCountry Garden, tells Julius Baer whyhe believes his country will go fromstrength to strength going forward.Country Garden is one of Forbes top 50 of when you think of our economic develop-listed companies in Asia 2011. To what do ment. Thanks to strong leadership, Chinayou owe this success? is one of the world’s largest economies nowadays. We have built a system that worksCall it ‘doing the right thing at the right time’ because it has been designed to suit us;if you like. I was born in an era of economic who we are, our scale, our culture, our needsand political reform that has pushed forward and our skills. It is my belief that China’sthe enormous growth of China. My business success story has just kicked off. There willis construction and the two go hand in hand. be many more opportunities for our peopleThere is nothing that can give you a better going forward.feeling than knowing you have contributedto the modernisation, urbanisation and pros What we need to focus on is education. Forperity of your country. We are thankful to any country to be successful in the longthe society for giving us such an opportunity. run, it must invest in the quality of its people.In return we are dedicated to leading people Our leaders have already set a good platforminto living a better life by producing good- for the further development of business. Ifquality products at fair prices. we can continue to invest in our people then the quality of their skills can only improveWhat do you think the future holds for that environment even more. We have alreadyChina? shown what we can do in terms of increasing productivity and ensuring that governance isThe way our country has progressed to date in line with the pace of social progress.pleases me. We have so much to be proud 34