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China: The 800-Pound Gorilla

June 18, 2018 | Global/Emerging Markets

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It may have been a strategic mistake for the Trump administration to walk away from the Trans-Pacific Partnership (TPP), because it damages U.S. influence in the region and allows China to fill the void. The door is now open for China to become the 800-pound gorilla in Asia (which may be why President Trump has begun talking about re-entering the agreement).

Increasing Investment

Foreign direct investment (FDI), particularly by Chinese companies, has the potential to transform Asia.

While investors have paid some attention to China's ability to attract FDI (with the country ranking among the top three destinations on A.T. Kearney's FDI Confidence Index since its inception in 1998), China's outward FDI is also driving change in the region.

China has increased infrastructure investments (including modern transportation networks, numerous energy projects, and special economic zones) in neighboring nations, most notably Central Asia, the Middle East, and Europe.

China is also providing the tourists who will use these projects. Its growing middle class is using its higher wages to explore Southeast Asia. Outbound travel is one of the greatest consumer expenditure categories in China.

Asian nations are happy to accept the wave of tourism.

In 2017, for example, the Philippines began granting visas on arrival to qualified Chinese nationals to boost tourism and investments. In 2017, a total of 968,447 Chinese visited the country (up 43.3% from 2016), overtaking the Americans to become the second top source market, according to the Philippines' Department of Tourism.

Cambodia's tourism ministry has even pushed a “China Ready Contest,” ranking tourist destinations based on whether they offer Mandarin language services and accept yuan as payment. There is plenty of room for growth, too—only 5% of Chinese citizens currently have passports.

The situation also works in reverse: What China gives, it can take away. When the United States deployed its Terminal High Altitude Area Defense (THAAD) missile defense system in South Korea in response to North Korea lobbing missiles around, the Chinese government was not happy.

In response, it cut off Chinese tourism to South Korea. A number of stocks in the travel sector—casinos and duty-free shops, for example—collapsed. Those restrictions have loosened a bit, but it's clear that China will use its economic power to strategically influence the behavior of other Southeast Asian nations.

While these developments may be the United States' loss, for the emerging market investor, they're a net positive, and that's why Chinese tourism is a significant investment theme in our emerging markets portfolios.

Todd McClone, CFA, partner, is a portfolio manager on William Blair's Global Equity team.