China’s Past Turmoils, Recent Developments & Future Outlook
China has been a recurring topic across past AIBC articles — in 2019 to 2021, we wrote about M&A trends and activity in China, last year, we gave commentary on China’s Evergrande saga and property market. This year, AIBC, being a conference with Asia-focus after all, finds it essential, again, to conduct a review of China. In this article, we recap the rollercoaster of events that has faced the Chinese economy and financial market, recent developments, and future outlook.
Recap of China’s recent headwinds
Over the past 3 years, 3 major events have clouded the Chinese markets and economy.
Tech crackdown (Mid 2020)
China’s crackdown on its biggest tech companies began in 2020 which forced Jack Ma’s Ant Group to suspend its $37 billion IPO just days before its launch.
Regulators then targeted the online financial service units of 13 other tech giants, including Tencent, Baidu, JD.com, Bytedance, Meituan, and Didi.
Property crisis (August 2021)
The fragility of the China real estate market was exposed when the behemoth-sized Chinese property developer Evergrande struggled to make payments on its debt.
Its debt payment struggles came after years of aggressive growth financed through debt was followed by slowing demand for its new buildings.
Social unrest from zero-covid (November 2022)
Colloquially referred to as the White Paper Protests, widespread civil unrest erupted following a 24 November building fire in Ürümqi that killed ten people, three months into a lockdown in Xinjiang.
The end of 2022 and the beginning of 2023 saw massive developments in China that signalled China’s possible reemergence from its past 2 to 3-year slump.
Property sector support (November 2022)
The People’s Bank of China (PBOC) and China Banking and Insurance Regulatory Commission (CBIRC) announced a 16-point rescue plan for the housing market, marking the most significant shift in housing policy since 2016.
To boost demand, further measures have followed, which focused on lowering down payments and relaxing restrictions around purchasing a home.
Easing of Covid restrictions (End November 2022 - present)
Just a week after landmark protests against the strict controls in late November 2022, Chinese authorities began to release some cities from lockdown.
In January 2023, officials announced the removal of quarantine requirements for inbound travellers.
Easing of Tech crackdowns (January 2023 - present)
In an interview in early January 2023, chairman of China’s Banking and Insurance Regulatory Commission, Guo Shuoqing, mentioned that the crackdown on fintech operations of more than a dozen internet companies was “basically” over.
“Next, we’ll promote the healthy development of internet platforms,” said Guo. “We’ll encourage them to come out strong in leading economic growth, creating more jobs, and competing globally.”
How did the markets react?
Almost immediately after the announcement of the easing of Covid restrictions and property sector support, markets saw the biggest slump in Chinese bonds in 3 years, indicating an auspicious sign for stocks.
In late November 2022, the yield on 10-year government bonds leaped by 27.6 basis points to 2.92%, the largest monthly increase since April 2019, according to Bloomberg data. This jump marked an end to an almost two-year bull run on the debt market, which saw the yield on the sovereign bond drop by 49.6 basis points through October from the start of 2021. (Bond yields and bond prices have an inverse relationship; when bond prices fall due to lower demand and more selling, bond yields rise). Fleeing safer assets such as bonds, investors moved money to higher-risk assets such as Chinese and Asian stocks, in anticipation of China’s economic recovery. Accordingly, the CSI 300 Index of yuan-traded stocks saw a 9.8% gain in November 2022, the best monthly performance since July 2022. The Hang Seng Index jumped 29% in November 2022, the biggest monthly gain since 2003, after sinking 40% from January through October.
Figure 1: Hang Seng China’s outperformance in November 2022
Numerous banks updated their outlook on China, turning bullish that China would outperform in 2023. Citic Securities, China’s biggest publicly traded brokerage, expects that the preference for stocks over bonds will extend into at least the first half of 2023 when China’s economic recovery is expected to accelerate amid a strong rebound in consumption and home sales. Furthermore, Citic expects a possible outperformance of economic growth, stating that full-year economic growth may reach 5% in 2023, compared to the consensus estimate of 3.2% expansion in 2022.
Both Morgan Stanley and Goldman Sachs upgraded Chinese equities to overweight. Bank of America Corp. said it has turned tactically positive on the country, while JPMorgan Chase & Co. (JPM) called the late October 2022 market meltdown a buying opportunity, indicating the possibility that markets bottomed then, and would only improve moving forward.
A rebound story too good to be true?
Considering China’s recent history of financial market turmoil, many investors have been left scarred and remain cautious when investing in China. In an interview regarding China’s reopening, Abrdn’s APAC CEO Rene Buehlmann views that the best long-term potential looks to be in areas such as China’s consumer sector, healthcare, wealth-related financial services, whilst also mentioning that a number of clients remain unconvinced on investing in China. “European and US investors are rather hesitant at the moment to go back into China in particular,” he said. Furthermore, there is nervousness around zero Covid limitations on domestic economic growth and global geopolitical tensions, which is counterbalancing investors’ fear of missing out on a rapid rebound in Chinese assets.
According to The Economist, many elderly Chinese have yet to be fully immunised as of the end of 2022, and efforts on getting the vulnerable vaccinated have been slow. Coupled with China’s underinvestment in healthcare and lack of hospital beds, China’s transition out of lockdowns may not be as positive as how the markets reacted it to.
Given the mentioned risk, it is worth noting as well that Chinese equities’ valuations do not look terribly compelling and cheap.
Figure 2: Multiples of major Chinese indexes
As of the end of 2022, MSCI China traded at an 11.7 forward P/E, compared to the Taiwan stock index at 12.4 and FTSE 100 UK at 10. The risk premium of Chinese equities might not be justified, given the track record of how unpredictable Chinese equities have been in the past 2 to 3 years.
Outlook: 4 key areas to look out for China’s reopening
China has been an outlier compared to the rest of the global economy, facing broad-based disinflation with lagging demand recovery despite steady production recovery. The consumer price index (CPI) averaged 2% growth in 2022, while countries like the US and the UK saw almost high single-digit monthly YOY CPI numbers. However, there are concerns that pricing pressure may spiral out of control and accelerate significantly during reopening, adding stress to global inflation throughout 2023.
Firstly, there could be supply-side constraints. Following the rapid removal of COVID-19 restrictions, there have been notable supply chain issues stemming from labor shortages and transportation delays, lengthening delivery times. Secondly, on the demand side, the post-reopening rebound could drive up private consumption and spending on services as pent-up consumer demand is realized. Combined, these could have a major impact on inflation, with core CPI perhaps ticking up toward 3% by the end of 2023.
2. Effectiveness of housing market policy pivot
Across sectors, housing was the largest drag on China’s economic growth in 2022 and the market registered record-low activity, despite policy adjustments introduced in late 2021. In 2022, new home sales fell 26.8%, new home starts fell 39.8% and real estate investment fell 10%.
Even with the introduction of new housing policies as mentioned previously, some analysts remain bearish on the housing market. For instance. JPM forecasts short-term housing activity to remain subdued due to post-COVID-19 low-income expectations, concerns about home delivery, and weak house price expectations, and for the wider housing market to reach a trough in the second quarter of 2023. In the longer term, JPM finds a strong rebound in housing activity to be unlikely as demand is a major constraint.
A possible reason for the lack of demand stems from flaws in some of the new measures. For example, dynamic adjustment mechanisms on mortgage rates for first-time homebuyers can only be implemented in cities where prices have declined over three consecutive months. Yet, with downward trends in both floor space sold and started, home prices have remained largely stable.
Figure 3: Downward trend of floor space sold and started, but home prices remain stable
3. Debt levels
Corporate debt, government debt, and household debt are the main drivers of debt in China.
Figure 4: Household, government and corporate debt are the main drivers of debt in China
While corporate debt has grown more slowly in recent years, this does not necessarily imply less vulnerability. Instead, this could mean the opposite as corporate balance sheets have been deteriorating since the outbreak of the COVID-19 pandemic. In fact, small and medium-sized enterprise (SME) loans have grown faster than other corporate loans and could be a possible vulnerability in 2023, with the potential for defaults to rise rapidly once COVID-19 rescue measures expire.
The other major risk factor is debt from local government financing vehicles (LGFV), which are set up to fund public projects. As they are similar to state-owned enterprises, their debt is classified as corporate debt and represents 44% of GDP. LGFV projects often have low profitability. This means debt repayment capacity is weaker, especially during an economic downturn. Furthermore, LGFVs are directly involved in the property market. Typically, they bid for land and may play an essential role in the provision of affordable rental housing. As such, this makes them susceptible to housing market corrections.
4. Monetary policy
While countries around the world have adopted quantitive easing (QE) - a form of monetary policy where the central bank purchases government bonds or other financial instruments to increase the money supply and lower long-term interest rates, we have yet to a similar move from China. PBOC Governor Yi has rejected the proposal of QE, however, the debate is unlikely to go away and will be one to watch. According to JPM, a rate cut of 10 basis points in the first quarter of 2023 is expected, but this will mark the end of the rate cut cycle. JPM expects the economy to begin recovering strongly in the second quarter of 2023 and the PBOC to keep rates unchanged.
While recent events have turned numerous investors away from China, one cannot deny China’s importance and it remains to be a key part of understanding Asian financial markets and economies. It will be interesting to see how recent developments unfold in China, especially given rising geopolitical tensions with the United States and its neighbouring Asian countries.