Dual circulation: opportunities in China’s new paradigm

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In March 2021, the Chinese government published its 14^th five-year plan, setting out its strategy for 2021–2025. At the plan’s heart is the concept of ‘dual circulation’. So what exactly is dual circulation, and why does it matter?

Dual circulation is not an entirely new concept; the Chinese leadership has been using the term since mid-2020, and it builds on earlier ideas. Essentially, it combines the expansion of China’s domestic economy (‘internal circulation’) with the serving of global supply chains (‘external circulation’). It’s a strategy that aims to marry self-reliance at home to continued success abroad. Crucially, the domestic market should become the mainstay of China’s economy with the overseas markets providing additional support.

The latest five-year plan indicates that the Chinese state will now play an even greater role in the economy than it did in the past. Part of this increased role involves trying to align the private sector with government priorities. The government’s focus is now on achieving a range of social objectives along with a higher quality, rather than quantity, of growth.

A strategic shift

The adoption of dual circulation signals an important shift in the Chinese investment opportunity. For decades, investors have viewed China as the world’s factory – simply churning out goods and exporting them. But this is changing, for two reasons.

First, China has a vast population that represents a huge consumption opportunity. The goods and services demanded by 1.4 billion people need to come from somewhere – and, increasingly, they’re coming from China itself. So, as consumption is upgraded – through greater wealth and aspiration – China’s domestic supply chains need to catch up. The ‘dual circulation’ strategy involves equipping the country’s supply chains to meet its growing domestic ambitions.

Second, dual circulation allows China to use the same supply chain for both its domestic and overseas markets. These two markets are enormous, and catering to them both is made possible by the elements the Chinese authorities put in place years ago: investment in talent and research and development (R&D).

An abundance of opportunities

Dual circulation offers abundant opportunities for investors. Many arise from the profound shifts in China’s economic structure: from old to new energy; and from primary and tertiary industries to the value-added portions of secondary industries – smart manufacturing and technological innovation, for example. Meanwhile, the authorities are trying to address the wealth imbalances between rich and poor. These themes look set to endure for decades.

At BlackRock, we see particular opportunities in what we call the ‘four Ss’: sustainability, self-reliance, social equality and (data) security.

Sustainability

Sustainability covers energy and the environment, among other areas. In the next decade, the Chinese authorities aim to increase non-fossil-fuel energy consumption from 15% to 25%. Many industry-specific policies have been put in place to support sectors such as wind, solar, nuclear and hydropower. China now has the world’s most comprehensive value chains in several of these areas, including solar power and electric vehicles.

Companies in these sectors are still generating phenomenal growth even as the overall economy slows. And market penetration is still at an early stage of the S-curve. With electric vehicles, for example, penetration has increased from 5% at the end of 2020 to around 20% already¹ in the recent months of 2021. Within a couple of years, this should rise to around 50%.

Self-reliance

To become truly self-reliant, China needs to increase the role of its domestic market because of the volatility of the external environment – as exemplified by the trade war with the US and the course of the global Covid pandemic. An area of particular interest here is consumption. Already, Chinese brands are taking market share from global brands in a whole swathe of sectors, from dairy products and beer to sportswear. And growth in consumer services offers further opportunity for investors.

Self-reliance is increasingly evident in technology, too. China is accelerating its R&D efforts and attempting to match the core technologies of the US and other global leaders. Trillions of renminbi will be invested in R&D over the next few years.

Social equality

The Chinese authorities describe social equality as ‘common prosperity’. Some investors have been alarmed by the concept and the accompanying regulatory crackdowns on technology and after-school education.

Not all of the outcomes have been negative, however. One result of this year’s crackdown on internet platforms has been a reduction of their pricing – to the benefit of consumers and small businesses. Another consequence has been better regulation. China’s fintech industry is a case in point. It is now under much greater scrutiny – which should reduce risks for consumers and investors alike.

Security

Finally, there’s data security. In the past, energy and fuel were the key resources for production, but data will be extremely important in future. So its security is becoming increasingly vital, and China’s domestic software and hardware companies should be well placed to cope with this.

All in all, China’s espousal of dual circulation underscores major shifts in its economy that have been underway for some time but are now gathering momentum. Investors should be alert to these changes and ready to embrace the long-term opportunities they will produce.

Source: NIO, 1 November 2021