The country has initiated several tough policy actions and launched its Common Prosperity program to tackle the main threats to both growth and internal stability. However, the jury is still out on whether these measures will prove effective. As the country’s influence extends far past its borders, the Robeco multi-asset team has been taking a neutral stance on both Chinese and emerging market equities in its portfolios.
Top of mind for investors
In 2022, China will likely be top of mind for investors, even disregarding the Winter Olympics to be held in Beijing in February. China as a single country has determined around 30-40% of annual global GDP growth in the recent decade, and it led the global economic cycle into recovery in 2020.
However, in 2021, China’s contribution to global growth faltered on the back of a policy-induced deceleration domestically while developed economies caught up. China’s main domestic engines of growth – real estate, manufacturing and infrastructure – have been sputtering lately.
With the monetary and fiscal impulse expected to decrease in the West into 2022, the fate of the Chinese growth trajectory becomes all the more important for the global economy. Therefore, now more than ever, investors should ask themselves: ‘What is on Beijing’s 2022 wish list?’ as the new year is finally upon us.
China’s economic power is so great that even minor wobbles in its growth trajectory affects other countries across Asia. Emerging market equities have underperformed relative to their developed world counterparts for the past few years, making them less attractive in a multi-asset portfolio.
One problem is that the growth in the country’s wealth has not been fairly shared among its 1.4 billion people, leading the government to introduce the Common Prosperity program. China is also seeking to improve welfare for the poorest to stave off any social unrest that threatens the regime.
In terms of wealth inequality, Chinese society is largely on par with the US, with the richest 1% of households owning one-third of the country’s wealth. It is President Xi Jinping’s fear that if this inequality persists, it will erode the middle class.
This would lead to polarization and the rise of the kind of populism seen in the US, potentially challenging the Communist Party. The Chinese political establishment realizes that the country’s major problems are to be found at home, given a very high total debt-to-GDP ratio of 270%, an ageing population that is starting to gradually worsen the dependency ratio, and increasing environmental costs.
Implementation is key
To address these long-term challenges, the Common Prosperity program is concentrated around three troublesome sectors. Implementation is key, and so policy makers have tightened the thumbscrews on sectors with significant concentrations of wealth and market power, notably the real estate, technology and education sectors.
For instance, the People’s Bank of China’s (PBOC’s) three ‘red line’ policies – a liability-to-asset ratio of less than 70%, a net gearing ratio of less than 100%, and a cash-to-short-term-debt ratio of more than 1x – amounted to forced deleveraging in the real estate sector. The most infamous casualty of this was Evergrande, which is now entering a debt restructuring process.
Hard to read the tea leaves
The question therefore arises as to whether the crackdown has worked, and whether investors could expect an easing of state interventionism in the corporate sector in 2022, which would bode well for Chinese and emerging market equities.
The evidence is inconclusive as it is hard to read the tea leaves in Beijing. The ongoing slowdown in housing sales and Chinese house prices from the crackdown hurts domestic consumption growth as the ’wealth effect’ is eroded.”
There is historically a strong positive correlation between Chinese consumption growth and domestic house prices, as the largest chunk of household wealth is determined by real estate assets.
Don’t forget Covid-19
Meanwhile, the Covid-19 pandemic continues to ravage across the world, led now by the Omicron variant which has caused a new wave of lockdowns.
Given the zero-tolerance Covid strategy, and the evidence emerging about the ineffectiveness of the Sinovac vaccine to protect against Omicron (even after a booster), lockdown intensity could increase in China in the near term.
This could additionally suppress domestic demand, even with the Winter Olympics approaching. Chinese policymakers will have to show their agility and ability to slalom around all these downside risks to growth.
Engineering a soft landing
All eyes will be on the response from the very top. In order to burnish his credentials as a socialist party leader ahead of the 2022 Party Congress, President Xi will likely be determined to safeguard social stability by engineering a soft landing for the economy in the near term.
Easing monetary policy through further cuts in the reserve requirement ration (RRR) and a bottoming out of the credit impulse in H1 2022, along with the use of fiscal stimulus and a loosening of housing regulations are the most obvious policy tools.
The PBOC and the finance ministry have already expressed their commitment in late December to ensure stable growth by hinting on lower taxes and providing reasonable and ample liquidity.
But the jury is still out
So, will it be enough? Although it is increasingly likely that deleveraging, decarbonization and housing wealth deflation is going to take a backseat as we enter 2022, we remain in the wait-and-see mode.
With geopolitical tensions with the US increasing (especially around Taiwan), the incentive for President Xi to bring domestic productivity wins forward in time by continuing his hard-handed interventionist policies is still there.
The Common Prosperity program is not a momentary event. This leaves considerable uncertainty on the table for investors. The potential for Omicron to trigger extensive lockdowns in China around the Winter Olympics is another headwind.
Although China’s policy muscles have clearly been flexed, the jury is still out on whether they can still do the heavy lifting. We remain neutral on Chinese equities and emerging market equities for now.