Investors with China exposure, or an appetite for it, face a raft of issues ranging from slower growth, which may or may not be condoned by Beijing, to toughened and expanded clampdowns on sectors. Add in persistent Sino-US tensions over geopolitics and a revitalised focus on greater common prosperity and this cocktail begs the question: How best to judge the outlook for China?
Chi Lo, Senior Market Strategist APAC, puts the latest developments into context, voicing his confidence that sentiment towards the world’s second-largest economy will improve.
Read the article or listen to the podcast with Chi Lo
The recent debt crises at major homebuilders has driven risk premiums on the debt of weaker Chinese firms to a record high and triggered a round of credit rating downgrades. Markets were rattled after a major developer with over USD 300 billion in liabilities and 1 300 real estate projects failed to pay interest on its international bonds. Other firms have warned they could default too.
The USD 5 trillion property sector accounts for around a quarter of the Chinese economy. In a sign that investor worries are growing, the risk premium on investment-grade Chinese credit has jumped to its widest in more than two months. The spread on high-yield debt has surged to an all-time high of more than 2 300bp, driving the cost of borrowing for these firms to well over 20%. [1]
Concerns over the possibility of an orderly restructuring of the property sector have been compounded by tightening coal – and hence power – supplies, adding to bouts of pressure, and not only on Chinese property shares.
Recovery should replace market volatility in the long run
Chinese stocks may see more market volatility in the near term, particularly over the regulatory tightening that we have seen in sectors ranging from property and construction to ride-hailing and other areas of the new economy. Especially in the property and building sectors, this has led to concerns about company liquidity and about high debt levels more generally.
However, these clampdowns, which are in part to tackle a lack of supervision, monopolistic power and anticompetitive control of big data, should be seen as a reform effort seeking to bring about more widespread prosperity. They aim to address what can be viewed as almost capitalist excesses that grew during the years when robust economic growth was considered the best antidote to inequality. [2]
Notably, this is not the first round of tightening measures with which Beijing is trying to reorient the economy. Previous rounds also saw investors become wary and markets become more volatile. These were short-lived phenomena that were followed by sustained recoveries lasting more than a year (see exhibit 1).
We expect to see a similar bounce this time round, with a clear recovery in the second half of 2022.
What we are seeing this time are different reform tactics. Beijing now favours the development of ‘hard tech’ hardware and components over ‘soft tech’ (e-commerce) expansion. This could lead to a shift in the engines of growth away from sectors focused on consumption.
We believe a reoriented economy still has the same earnings potential. In the new environment, we can expect more from high value added manufacturing and high-tech industries, while the market expectations for the ‘old’ industries that are under scrutiny will have to be adjusted downwards.
Signs to watch for
The signs to monitor include People’s Bank of China policy moves in open-market operations, changes in the bank reserve requirement ratio and in the interest rates of its lending facilities. We believe the central bank will maintain its policy easing bias, not least in light of news that economic growth weakened in the third quarter to 4.9% amid the property slowdown and energy shortages.
PBoC actions should allow for a boost to the credit impulse – the flow of credit to companies and households – and hence GDP growth.
Another factor concerns the issuance of local government bonds that will go into funding investment. That should also underpin (a recovery in) Chinese growth.
Outlook for China – Look beyond the recent ructions
As for the outlook, investors should take a longer-term perspective. The prospects are good, in our view, certainly as long as China’s moves to open up the economy and its capital markets make progress and Beijing remains open to the role of market forces in the economy.
Growth should pick up again on back of fiscal and monetary easing and expectations of more to come. Beijing might even go so far as to row back on some of the restrictions it imposed on the property market if it feels the measures are too draconian and could hurt the wider economy and cause social unrest.
Then there are the concerns over the different directions of US and Chinese monetary policy. We view these as overblown.
As said, the current easing stance by the PBoC should help mitigate risks that Chinese growth will slow further. That should cap any impact of the slowdown in growth on China’s ‘backyard’, i.e., wider Asia. As for the US Federal Reserve’s moves towards a tighter monetary policy, we believe stronger US growth is facilitating this. This should also support growth in Asia.
On balance, the monetary policy divergence between China and the US may not be bearish for Asia’s – and China’s – economic outlook and asset markets.
‘Invest in China for China’
Investors have worried that continued Sino-US tensions – over trade, but also non-economic issues – could result in a drop in trade as regional supply chains and production are re-shored under ‘own nation first’ policies. However, we have seen no convincing evidence that Asian, or indeed global, supply chains are being broken up or that the US and Chinese economies are decoupling (see exhibit 2).
In fact, Asia’s supply chains have so far simply shifted rather than broken down or contracted. Indeed, contrary to conventional wisdom, Asian supply links have integrated further with China. [3]
Here too, we believe it is important to understand Beijing’s strategic targets, which include lowering the country’s reliance on external supply sources. In the same vein, it seeks to develop local cutting-edge technologies. It sees innovation as a route to common prosperity and wants small and medium-sized firms and the private sector to drive innovative change and fund the development of hard tech.
So, to come back to the regulatory crackdowns, these are not meant to rein in the private sector, but to align private sector interests with Beijing’s strategic targets.
Looking at recent developments, we believe they endorse our ‘Invest in China for China’ view held since the US shifted its China policy from constructive engagement to strategic competition in 2016.
[1] Data as of 13/10/2021. Source: Chinese property firms suffer fresh downgrades amid Evergrande crisis | Reuters
[3] Also read Decoupling from China? Not really – Just a shift in Asian supply-chains – Investors’ Corner (bnpparibas-am.com)
