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China: Gently Applying the Brakes

He’s a few months into his new term as re-elected president, so how is China’s President Xi Jinping continuing to shape the world’s second-largest economy for the future? Investment director, Michael Lai takes a look.

Tuesday, February 27, 2018

“Strong and stable” may have become something of a cliché in recent times, due to its repeated use as a mantra by the UK government, but it is nevertheless the ideal state for a successful economy and one which most countries aspire to. Achieving this ambition also tends to require strong and stable leadership and based on that measurement alone, China’s chances are looking good.

The Party showed its faith in its incumbent President, Xi Jinping by re-electing him for another five-year term in October last year, at the country’s 19th National Congress. And that’s not all: every world leader likes to leave a legacy and the president achieved that goal. His position in China’s history was cemented with the enshrinement of his principles in the party constitution. To be clear, this honour is not automatically conferred on every leader and is a measure of his success, as China’s economy transitions from the ‘old’ to the ‘new’ model.

Balanced and sustainable

President Xi Jinping’s version of strong and stable is “balanced and sustainable” and his focus on this objective for China is a sign that the country’s political economy is now entering another new era in its evolution. In other words, it is moving from the previous stage, where the economy was characterised by rapid growth, to the next, where the watchword is quality over quantity.

The objectives set out by the Congress were echoed in the Central Economic Work Conference, which sets out the economic agenda for the year ahead. It emphasised the focus on the quality of growth while also prioritising the containment of financial risk – another key factor in China’s plans.

Balancing the books

It is no secret that addressing financial risk is high on China’s agenda, so bond yields quickly moved higher after the Congress, as the market expected the government to continue its campaign to reduce borrowing levels.

And it did not take long for the government to take action: in November last year additional measures were introduced, to ‘squeeze’ the shadow banking sector, with the People’s Bank of China tightening controls on asset management products. The new rules represent a coordinated approach by the regulators and it seems this could be the new norm. New restrictions on online micro lenders were also issued in November, to slow down China’s demand for consumer credit. Bond yields subsequently spiked again, but we do not believe this to have been detrimental.

While containing debt requires a tighter monetary policy backdrop which inevitably decelerates economic activity, China’s healthy exports and domestic consumption are powerful engines of the country’s new economy, counterbalancing the impact of the financial sector reforms.

It is a challenge for the government to maintain growth levels while simultaneously putting the brakes on spending. But it is not only focused on clamping down on debt. Another key element of the country’s ongoing financial reforms is to emphasise the importance of equities rather than relying on debt. Progress is being made here in the form of the Hong Kong Stock Exchange allowing dual class share structure to help attract ‘new economy’ companies to list on its main board. This could allow more high-growth companies in China to potentially list in Hong Kong. Another development in this area is the inclusion of A shares in the MSCI emerging market benchmark indices from June this year.


Financial change is not the only change on the horizon. China is also continuing to seek to improve its economic structure and foster new growth through advanced manufacturing, rural revitalisation, coordinated regional development and state owned enterprise (SOE) reform. Looking at SOE reform in particular, our view is that it is likely to accelerate in the coming year. Historically, the main challenge of SOE restructuring has always been the redundancy process. In the 1990s, following Zhu Rongji’s reforms, around 50m workers were displaced from their jobs. In this current cycle, some 5m workers have been let go, from jobs in old economy sectors, particularly steel and coal, due to a reduction in capacity. On the other hand, close to 15m new jobs have been created within the new economy, across e-commerce and logistics in the services sector. The creation of new jobs is being fuelled by the booming domestic consumption which is helping drive growth.

Onwards and upwards

So, what’s on the horizon for China in 2018? We expect GDP growth to moderate slightly, from 6.8% in 2017 to 6.7% in the year ahead, in line with the government forecast, but there are positive signs. For instance, MSCI China ended 2017 on a high note, with its twelfth consecutive monthly gain.

To sum up, as long as monetary policy does not tighten significantly, which could increase the risk of a faster economic slowdown, we believe China can still deliver healthy corporate earnings and experience a positive year market-wise in 2018.

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