Foreign investors were reassured by Chinese President Xi Jinping’s comments about his economic reforms going forward, as the 19th National Congress of the Communist Party of China came to a close last week. Knowing that Xi will stay the course “gives me the confidence and clarity that what we have been seeing over the last five years is going to continue,” said Andy Rothman, investment strategist at investment firm Matthews Asia. “It means our current investment strategy approach to China is also going to continue.”
After decades of fast-paced growth, China has now been introducing new governmental policies aimed at slowing growth, controlling financial risk, regulating the real estate market, reducing leverage, and doing more to protect and clean up the environment, all in an effort to improve the economy’s long-term growth potential, said Hayden Briscoe, head of fixed income Asia Pacific, UBS Asset Management.
Investors should expect more of the same going forward. “The deleveraging process that has tightened liquidity, increased money market rates, raised bond yields, and forced credit growth to contract since late 2016 will continue,” Briscoe wrote in his paper, “Fighting with Both Hands—What a Stronger Xi Jinping Means for China’s Outlook,” published on October 26.
The country is currently experiencing what Briscoe calls “a mini-cyclical economic slowdown,” but investors have no reason to be alarmed, he said. “The Western lens often overreacts when they see slower growth in China’s main economic indicators, and they start to think things will blow up. We are not in the blow-up camp,” he said. Rather, he sees the slowdown impacting the rest of world through weaker trade flows that will impact emerging markets.
Teresa Kong, lead manager, Matthews Asia Strategic Income Fund and Matthews Asia Credit Opportunities Fund, is also encouraged by China’s current fiscal moves. “The Chinese authorities understand the hazards of leverage and are working to bring it down,” she said. “They are doing this by tightening access to short-term credit, and thus raising the cost of capital. For investors like ourselves, this has created higher yield curve and higher credit spreads, which offers good opportunities.” Briscoe also sees these moves as a plus for investors. “In our portfolios, we are looking to add Chinese long bonds in the 3.7–4.0% range,” he said.
Also significant for investors was the change, for the first time since 1981, of the Communist Party’s mission statement. “What we now face is the contradiction between unbalanced and inadequate development, and the people’s ever-growing need for a better life,” said Xi in a speech at the Congress. The Party’s new policy will address these inequities by focusing on the quality of growth, rather than just the speed and quantity of output, Rothman explained.
“I think he is reaffirming what we have seen over last few years: his commitment to dealing with income inequality, healthcare, pensions, education and terrible pollution,” said Rothman. While this policy is not new, the fact that it will continue is encouraging to investors. “Government spending on all these programs rose at a double-digit annual rate, during Xi’s first five years, so, what he is doing now is confirming that these will remain his priority during the second term,” Rothman said.
Xi will also continue to transition the Chinese economy from being driven by industry and exports to an economy driven by consumption. “This year is the sixth year in which the consumer and services part of GDP will be bigger than the manufacturing and construction part,” said Rothman. “Two-thirds of economic growth in China is coming from consumption, up from 40% 10 years ago.” With those figures in mind, Matthews Asia is planning to continue its current approach to investing in Chinese companies that sell goods and services to Chinese people, Rothman noted.
Also of note to investors was the fact that Xi’s allies now dominate senior positions within the Communist Party for the first time since he came to power, giving him the muscle he needs to get his policies enacted. Previously, “Xi Jinping did well managing the economy with one arm behind his back, when senior officials were not his own people, but now they are,” said Briscoe. “His stronger power base following the CPC means he will be able to fight with both hands for an agenda that will prolong China’s mini-cyclical slowdown, but create attractive opportunities for investors in China’s bond market.”
Xi Jinping also confirmed that he will continue to promote the growth of entrepreneurship as part of the Chinese economy, as opposed to just state-owned enterprises (SOEs), which have been the primary economic engine for the country. This, too, will be done at a slow pace. “Because the authorities wouldn’t want a high concentration of unemployment in one area, it would be unwise to quickly phase out over-capacitated industries,” said Kong. “In the case of aluminum smelting as an example, the authorities are, indeed, mothballing older capacity as new, greener capacity comes online, holding overall capacity constant,” she said. The government will look to shut down outdated factories that pollute or don’t comply with new environmental standards, Kong added.