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What’s in store for China in the Year of the Monkey?

It is the Chinese New Year and the country continues to dominate business headlines, mostly negatively. “Be scared of China’s debt, not its stocks”, “China’s credit binge is the real concern” and “China’s currency conundrum: Cause for alarm” wrote Bloomberg, The Financial Times and CNBC, respectively, in January. The Monkey has already started playing the fool ahead of its arrival on 8 February – the equity markets sold off in January and global stocks dropped more than 6% in one week, which was the worst performance over a four-year period. Many blame China for the troubles in the markets, but are these accusations justified?

 

Numbers out of China do look staggering: the country with a population of 1.4 billion has an improved demographic outlook, after abandoning its one child policy last year. In 1980, China consumed about 3% of the world’s oil, and this share has grown to around 10% by 2016. The only country consuming more oil is still the US, but China is catching up. In 2015, Chinese oil consumption was close to 11 million barrels per day, and this was 7% more than they used the previous year. Furthermore, assuming economic growth in China is some 3%, half the ‘official’ number of around 6%, this year China will still be adding close to US$400 billion to its economy, not far away from what the US – the world’s largest economy – adds.

China – the risks

The bears (those who think the financial market will go down) claim that the country is on the brink of a systemic financial crisis. They believe it has built too many industrial sites, houses and shopping malls and is burdened by heavy debts. They see rapid capital flight out of the country. Experts estimate that close to US$800 billion left the country in 2015, and if true, this zeros out all economic growth in China last year (going by the ‘official’ numbers above). Reduction of capital results in falling currency reserves, creating pressure to keep the renminbi at a seemingly overheated level to maintain the reserves and also the ‘macho’ image of China globally. Add to this falling demand for a number of basic products and services, from electricity to bicycles, and the prospect emerges for masses of industrial workers to become unemployed.

Another major risk is the potential scope for a sharp devaluation of China’s currency: could the renminbi weaken abruptly by over 20%, like some emerging markets currencies have? The actual weakening of the renminbi against the US dollar has been quite moderate so far, around 6.5% from the start of 2014, which was the currency’s 10-year high against the US dollar.

A more positive perspective

On a positive note, since 2012 we have seen China’s economy start to transition away from a heavy focus on manufacturing model towards a greater emphasis on services. Our chart illustrates that this transition has been gradual, but current governmental policies and ongoing reforms are paving the way for it to continue. Internet retailing, telecom and associated technologies have been booming. E-commerce platform Alibaba (the Amazon of China) had 350 million users in 2015, and with over 600 million (and growing) Chinese using the Internet, the growth potential of the company is still impressive.

Our chart: China grows services as manufacturing shrinks

chinese new year chart

Sources: CLSA, CITIC Securities, September 2015

GNI (gross national income) per capita has increased from US$1,740 in 2005 to US$13,200 presently, according to the World Bank, making it nearly a quarter of that of the US. Clearly, Chinese people are materially better off, compared to just 10 years ago, and have been buying more products and services. This will certainly further fuel the tourism, education, entertainment, healthcare and e-commerce industries. While there are still large differences between wealth in the cities and poverty in rural areas, providing residency permits (so-called ‘hukou’) for millions of unregistered workers in cities is one of many small steps towards bridging this gap.

While The People’s Bank of China lowered the country’s interest rates six times last year, intending to somewhat normalize the credit conditions and manage high corporate debt levels, the rate is still above 4% – high by current Western standards – and the Chinese policy makers still have some room to manoeuvre.

China has been rebalancing its economy, and while consumption and sales are down and flat in many areas, the government’s intervention has prepared the country for domestically driven growth. Looking ahead 10-15 years, we may see results that could translate in sizeable returns for investors.

China is a controlled economy with a five-year plan: the next deadline is 2020. The government is already pursuing the ‘Made in China 2025’ plan, which aims to have 40% core components and materials made domestically by 2020, growing further in the future. Optimists and the bulls (those who think the financial markets will go up) believe that China’s policy makers have the necessary tools to deal with the mountain of issues, but even if they are right, investors are likely to see continuing volatility in the markets for some time. We remain cautious about investing in China and most Asian and Emerging Market funds we rate highly are currently underweight China. At any rate, the Chinese businesses these funds own are perceived to be robust for any economic conditions and should be able to whether the economic storm, should it occur.

Our top fund picks


Our top picks for investing in Asia are Schroder Asian Alpha Plus, Stewart Investors Asia Pacific Leaders, Fidelity South-East Asia and Invesco Perpetual Asia. These portfolios are aimed to outperform broader index funds and grow investors’ capital over time. They also offer diversification, taking advantage of opportunities elsewhere in Asia.

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