China is entering a new stage in its development. As the nation’s priorities shift, its growth model, and the new focus on “common prosperity” suggest the goal of better equality is rising above absolute efficiency. Such a change has long-term implications for policy making and has already led to material changes in industrial policy, regulatory tightening in selected sectors, and a change in emphasis in macro policies.
With growth momentum slowing in the second half of the year, and other downward pressures, China will likely become a smaller driver of global growth in the coming quarters, especially in light of the continued recovery elsewhere. Standard Chartered expects China’s real GDP growth to moderate to 5.6 per cent in 2022, from 8.2 per cent in 2021.
Standard Chartered also expects, exports will continue to play an important role in driving growth in 2022, but the pace of exports growth should slow from the current record high levels. While consumption could play a bigger role, especially if there’s a change in China’s zero-COVID policy, investments will probably remain relatively weak, as a likely rebound in infrastructure FAI (fixed-asset investment) is unlikely to fully offset reduced property investments in the foreseeable future.
Against this backdrop, policy makers are already considering a longer time frame when deliberating policy tools and plan to take targeted action sooner - a cross-cyclical approach - rather than intervening as soon as there is a slowdown in growth or an uptick in inflation.
What that paradigm shift means for investors in the coming months is a gradual and lengthy policy easing cycle, where a slower pace of growth is accepted, as long as the labour market remains stable. At the same time, pockets of opportunity are continually materialising. For instance, multiple data sources show that sectors like healthtech, hardware, and consumer market solutions are still attracting quite significant levels of VC investment in China.
“China has been a major export country, but in the coming decades, it will become a major consumption country and also a major importer in the world,” said Becky Liu, Head of China Macro Strategy, Standard Chartered. “What that means for regional economies, especially for emerging markets is that we will be looking for an even closer integration of the trade partnership between China and these countries. And China will also import more from regional countries, boosting their growth from that perspective as well.”
Investor appetite for Chinese assets remains strong and foreign inflows continue, bolstered by the inclusion of the nation’s government bonds in three major indices. FTSE Russell which has started including China government bonds in its FTSE World Government Bond Index since October 2021, will be generating passive inflows of between USD130 billion and USD160 billion in the next three years, Ms. Liu estimates.
Chinese assets remain underrepresented as a proportion of global investment portfolios, signifying huge potential for catch up. Foreign holdings1 of Chinese government bonds have risen but are still low versus major markets.
Investor participation is already playing a much larger role in China's domestic bond markets. International ownership of domestic China government bonds exceeded 10 per cent this year and the net purchase exceeded 30 per cent of net issuance this year. The emergence of dedicated China bond funds and the fast growth of exchange traded funds dedicated to China are also spurring international flows.
“There are a couple of things that will continue to make China’s fixed income market very attractive,” said Charles Feng, Head of Macro Trading, Greater China North Asia, Standard Chartered. “Looking at the global comparison on interest rates and the theme of inflation pressure globally, real yields, which are the interest rates adjusted for inflation, are substantially higher in China than they are in both the US and the Eurozone, for both the short end and the long end of the yield curves. In the meantime, the China bond market offers good diversification to global investors as the correlation between its yield movements and the yield movements in major developed bond markets has been very low, often even at the opposite direction.”
Strong capital flows are also helping bolster the currency, alongside the trade surplus and foreign direct investment. While this is likely to be sustained, the authorities want a stable yuan and will not want to see too much more appreciation.
“The authorities might step up measures to cool down the appreciation of the CNY, especially now that China's growth momentum is going down,” said Ms. Liu. “Exports will remain an important driver of China's growth and therefore we're only looking for limited strength from here.”
All this signifies a paradigm shift in policy and management of the economy. As China becomes less export oriented and with growth becoming increasingly dependent on domestic consumption, a slower, more balanced mix is emerging and a more even wealth distribution.
The authorities are also shifting how they support the economy and their levels of intervention.
Looking ahead to 2022, the government is likely to focus on domestic job growth. At the same time, there will also be opportunities in green investing, as China funds the energy transition.
While risks like regulatory tightening and credit events need to be navigated on a sector-by-sector basis, the bigger picture appeal for investors remains unaltered in 2022 and beyond. Deep local knowledge and expertise will help international investors side-step these changes. And, ultimately, China’s rapid opening up makes now a great time to be seeking opportunities.
This article is based on themes discussed during a panel at Standard Chartered and Bloomberg Media’s recent investor forum – Emerging markets 2022: Investment strategies for a brave new world. View the recording.