CHINA FOCUS: A reason for cautious optimism

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In the first half of 2022, the global economy was marked with recession fears, rising inflation and disruptions caused by ongoing geopolitical tensions, officially marking the end of the boom conditions of the year prior. In technical terms, we are in a recession, yet the situation is far more complex as most markets, interestingly, have already priced in the odds of a recession, while key economic indicators such as consumer spending and employment figures remain optimistic. In an attempt to tame inflation, most central banks around the world — most notably, the US Federal Reserve — have tightened policy and hiked their interest rates over the course of the second quarter. However, there is one exception — China.

1H2022 economic overview

The Chinese economy has encountered myriad problems since 2022. While the rest of the world has accepted living alongside the coronavirus in an endemic situation, Beijing has insisted on maintaining a stringent Covid-Zero policy. While Covid-Zero has kept infection figures low, it has come at a great cost to the Chinese economy, as lockdowns have all but stagnated all activity in affected regions. Gross domestic product growth declined to just 0.4% for 2Q2022 and it is increasingly likely that China would miss its official growth target of 5.5%. Economic woes were further intensified by regulatory crackdowns on the private sector and, more importantly, the mounting real estate crisis that is causing bad debts to rise. China’s property sector, which has been the main driver of the country’s economic boom, is the world’s largest asset class, accounting for 15%-30% of total GDP. However, policy attempts to deflate the housing market bubble and to ensure that houses were “for living in, not for speculation” has ended up with major developers being saddled with debt and unable to borrow further, resulting in a severe cash crunch, defaults in repayment and delayed project completion, which will eventually jeopardise the overall economic prospects. In response, angry citizens have staged nationwide protests and boycotted mortgage payment.

Despite all this, we still remain cautiously optimistic over the prospects of the Chinese economy for the remainder of the year. The key to the Chinese economy’s recovery is how the authorities handle the next wave of Covid-19 outbreaks and the myriad problems within the housing market. Still, if past precedent is anything to go by, there is reason for hope.

Keys to recovery

First and foremost, the Chinese government would almost always take an active role in the event of a crisis, stepping in with a combination of fiscal and monetary policy whenever necessary to prevent a complete economic collapse. As central banks across the world hike interest rates, the People’s Bank of China (PBoC) has gone the other direction, cutting key lending rates in an attempt to stimulate consumer and business demand, with the latest being cuts on Aug 21, cutting its five-year loan prime rate to 4.30% from 4.45% and its one-year loan prime rate to 3.65% from 3.70%. This comes shortly after 10-basis-point cuts to both its one-year and seven-day lending rates on Aug 15. On the fiscal side, the Chinese government has repeatedly rolled out a raft of tax relief measures — with the latest report in March suggesting that the government has pledged a total of CNY2.5 trillion in tax refunds and reductions in 2022 — and has also repeatedly issued local government special purpose bonds (SPB) to finance infrastructure, energy and transport development. On Aug 30, the Ministry of Finance reaffirmed the government’s commitment to proactive fiscal policy, pledging to continue implementing preferential tax and fee policies.

Secondly, we are of the view that much of China’s existing economic woes can be alleviated with a change in its Covid-19 management strategy. The most effective way to restore domestic business and consumer confidence is for the government to relax the stringent measures, where consumers and businesses would no longer have to worry about being suddenly restricted from leaving their homes or operating. While it is very unlikely for the Chinese administration to fully abandon this long-standing Covid-Zero policy, we have witnessed signs that it is softening its stance. The Politburo meeting on July 28 indicated an emphasis on the country’s Covid-19 policy to be flexible, striking a balance between pandemic control and economic development. This is given the recovery story we have witnessed across the world as Covid-19 restrictions ease, as well as the brief rally in the Chinese economy back in June resulting from fewer lockdown measures.

Lastly, we believe there are foreign and domestic factors that would benefit the Chinese economy for the second half of 2022. Externally, we believe that the aggressive interest rate hikes by central banks across the world would eventually taper off. And even if the hikes do continue — we do expect so for the foreseeable future after the Fed’s hawkish comments on Aug 26 — markets have already priced them in. To put it bluntly, given the myriad of unpredictable geopolitical events in the first half of 2022 — a full-fledged war between Russia and Ukraine, decade-high interest rates and a full deterioration of relations across the Taiwan Strait due to US House of Representatives Speaker Nancy Pelosi’s visit to Taiwan — should any of these abnormal situations improve, so too would the global economy. Domestically, we are encouraged by the latest rhetoric by government bodies on the country’s private sector — particularly its tech giants — which should hopefully signal the end of the harsh crackdowns over the past two years. On Aug 19, China’s internet watchdog, the Cyberspace Administration of China, gave its strongest public endorsement of domestic technology companies raising funds overseas, stating that it “always supports domestic companies to raise funds overseas in capital markets in accordance with laws and regulations”. To add to optimism, US and Chinese regulators have tentatively reached an audit agreement after two years of bickering, which would allow for cooperation on inspecting the audit work papers of US-listed Chinese companies and for mutual assistance on any inspection matters. This greatly reduces the risk of Chinese stocks delisting from American exchanges.

Portfolio strategy

In alignment with the Politburo’s policies, we favour new energy and industrials sectors. There is an emphasis on carbon reduction, which would in turn support the accelerated development of new energy vehicles (NEVs) and renewable energy.

We are getting more positive on the internet and ADR space, especially with the intense scrutiny of the internet sector nearing an end, as signalled by senior Chinese leadership. We are cognisant that Chinese consumption may have a delayed recovery, but it will gradually recover as Covid-19 restrictions ease. Any improvements in US-China relations will have positive implications in the internet and healthcare sectors. We anticipate that China will start to progressively reopen its borders from early 2023.

We anticipate continued loosening measures in the property sector, given the recent slowdown. We believe that the property sector will take some time to recover, but there are opportunities for strong property companies and property management companies.

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