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A broader understanding of China’s recovery
11 Aug 2023
- China’s policy support this year will focus on the five per cent growth target
- Market valuations are currently seen as inexpensive
- Further assistance for the property sector could be in the pipeline
- The government needs to balance short-term policy action with its longer-term goals
- Youth unemployment remains elevated, but renewed business confidence would provide stability
- The banking sector remains robust, with room for lower mortgage rates
- The integrated nature of the global economy tends to dispel concerns about de-coupling
Markets are starting to rationalise that growth in China will be softer than expected. However, this realisation should not come as a surprise, given government moves to deliver a sustained recovery. To analyse China’s economic backdrop in more detail, Fidelity’s Global Chief Investment Officer Andrew McCaffery met with Vanessa Chan, Head of Asian Fixed Income Investment Directing and Jing Ning, Head of Equity Research China, to assess how the country has progressed in the months following the post-pandemic reopening.
“We have always believed that China would experience a sustained recovery that wouldn’t be marked by high levels of stimulus,” says McCaffery. Instead, it would be about ongoing policy support focusing on five per cent plus growth this year. GDP for the second quarter certainly disappointed the markets, but it aligned with what Fidelity’s analysts observed across the economy.
“From our recent conversation with businesses, there’s a sense that growth has slowed. There were also low expectations for a robust policy response,” adds Ning. Fidelity’s recent company visits also highlighted a mixed picture in other areas. For instance, the mood is generally upbeat in consumer segments like travel, lodging, and cosmetics. Conversely, there are no tangible signs of an upturn in sectors exposed to the property market, with pricing expectations in Tier-1 cities starting to move lower. Overall, consumers are conscious of gaining value without sacrificing quality.
“When we think about how we engage with China from an alpha-generation perspective, the view is that the market is inexpensive at present,” says Ning. However, the upcoming H1 earnings season could produce positive surprises. “Our analysts are certainly looking for investment opportunities but exerting caution given the mixed picture across market sectors.”
Property weakness could trigger further stimulus
Turning to real estate, Chan observes, “We need to acknowledge the physical market has weakened.” Not only have lower-tier cities experienced negative sentiment, but some higher-tier cities were also under pressure in terms of transaction volumes and prices.
We should see the continuation of a targeted approach as the government waits for economic drivers to shift from infrastructure and property to manufacturing and consumption.
Another factor to consider is the reform of local government financing vehicles (LGFVs) that provide local authorities with funding to bridge fiscal deficits. These vehicles have existed for around a decade and issuances have grown strongly in the onshore market. Without direct bailouts, the reforms could see a rebalancing of the commercial aspects of LGFVs to create more fiscal equilibrium among local governments.
“We are at a crossroads,” observes Ning. There’s a risk that short-term policy moves bring unintended consequences, for instance, more relaxed property restrictions could see the market reheat. Therefore, there is a need to introduce short-term measures that provide stability but balance these with clarity on the longer-term policy framework.
Rising business confidence would boost youth employment
Job creation in China has slowed in recent years, not just because of the pandemic but also in response to regulatory tightening in, for instance, the technology, innovation, education and, to some extent, property segments. China’s youth also face a skills mismatch, with more jobs being created in the service sector than in highly skilled areas.
“Over the longer term, youth unemployment is expected to reduce. What would help is a restoration of confidence, particularly among small- and medium-sized firms,” says Chan. The authorities are also introducing measures aimed at stabilising the employment situation. These include internships and subsidies.
A healthy banking sector
“A healthy banking system and fixed income sector are priorities for the People’s Bank of China (PBoC), which gives us confidence, as does the fact that the banking sector appears structurally sound,” explains Ning. There have also been discussions on mortgage rate adjustments. Most mortgage loans in China are priced at a fixed rate, with many paying between 4-6 per cent. However, the 7-year government bond yield is now below 3 per cent, so there is room for savings if the mortgage rate is revised lower to reflect the current long-term yield.
The big-four banks may also consider issuing long-duration debt instruments to replace some of the long-term LGFVs, some of which will be restructured with a longer duration and lower yield. To keep the system functioning, the PBoC needs to maintain a minimum profit margin among the banks so they can continue to provide financing for the economy.
Changing geopolitical dynamics between China and the US
“Rather than talk about de-coupling, it’s more apt to use the term de-risking. The global economy is so interconnected that de-coupling is hard to envisage,” notes McCaffery. We have the US presidential race next year, so there will be a desire to ensure that the economy remains resilient and inflationary pressures are reduced. If China were to weaken, that could create more damage. Corporations have also made enormous investments in China, so undermining these would be problematic. “This is where practical realities start to kick in, as we have seen with an easing of tariff rhetoric from the US,” he concludes.
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