Anxiety over capital flights and imminent currency weakness were palpable in early 2016 after the People’s Bank of China (PBOC) allowed a one-off sharp devaluation of the renminbi (RMB) in August 2015. Tighter liquidity conditions weighed on sentiment, leading to a precipitous sell-off in early 2016. This dragged world bourses lower and became exacerbated when Beijing implemented circuit breaker intervention to force a pause to trading if share prices moved too dramatically in one direction. The decision by state investment funds to force domestic buying and limit selling was seen as a step away from Beijing’s reform path, discouraging foreign investors from looking at China’s economic prospects.
Over the subsequent 12 months, resilient macro data and a more communicative PBOC reassured market sentiment, which came amid a backdrop of negative interest policies by the European Central Bank and Bank of Japan. Capacity cuts across industrial plants producing coal and steel were enforced, boosting commodity prices which translated into a positive Producer Price Index (PPI) in September for the first time since early 2012. Beijing was also quite prepared to use more than USD $300bn in foreign reserves over 2016 to offset currency weakness showing prudence and providing domestic stability as a counterbalance to the external events of Brexit and the election of Donald Trump.
The recovery last year provided tangible evidence of growth and gave reassurance going into the 2017 National People’s Congress. Premier Li Keqiang delivered the nation’s work report with an economic growth target of “about 6.5%” with a clear emphasis on mitigating financial risks. This reflected a more realistic plan for growth that was somewhat lower than the projections of the two previous years. Although 6.5% is the minimum needed to maintain the earlier ambition to double the economy by 2020 from 2010 levels, it appears that the government’s priorities have shifted for the better. Achieving such a growth target by 2021 would be hugely symbolic as it would coincide with Beijing's celebrations of the 100th Anniversary of the Chinese Communist Party. With overconfidence creating potential risk around unsustainable growth the clear emphasis on state control should act to limit concerns.
The efforts to highlight potential domestic hazards and adjust growth projections accordingly reflects a more realistic approach. Looking through the key indicators, it is especially encouraging to see the recovery in PPI. After bottoming in late 2015, China’s producer prices have improved incrementally which has significant implications not just economically, but politically given the difficulty of making any progress with supply side reforms. If PPI were to rest above zero for an extended period, this would bode positively for corporate earnings by lowering the real cost of servicing debt. An inflationary environment also allows the PBOC to move away from an accommodative monetary policy towards a more neutral one. While the PBOC is likely to maintain credit growth of 12%, there is an expectation of more liquidity flowing into productive sectors and private enterprises. This complements Premier Li’s other target of a 3.0% fiscal deficit to GDP for this year.
Much of the optimism towards Chinese equity markets stems from economic data conducive to earnings growth and an appropriate central bank monetary policy that provides RMB support. Beneficiaries include the financial sector as concerns over asset quality reduces while non-bank financials, such as insurance companies may see asset revaluations. Policymakers have also pushed for greater participation for public-private partnerships to support growth, benefitting contracting companies. Ongoing supply side reforms should also be a positive for the industrial sector once economic influences become more dynamic.
Stability in China also creates a spillover effect into the rest of Asia, particularly economies in South-east Asia, India and the ASEAN markets. Beijing’s edict promoting liberal multilateral trade encourages better economic links and more outbound investments. There are signs of this approach with Sino - ASEAN talks to improve relations over disputed territorial seas in exchange for greater trade and cooperation. Engagement of the Regional Comprehensive Economic Partnership (RCEP) of 16 nations and the One Belt One Road (OBOR) initiative come at a time when the new US administration prefers bilateralism in global trade. Stability in China has the potential to drive greater intra-regional dynamism, which is particularly important as instability becomes more evident elsewhere.
Assistant Fund Manager - Asia