As China’s economic challenges grow, will investors lose confidence?
- Although it’s looking increasingly unlikely that China will hit its 2022 growth target, Beijing is determined not to resort to aggressive stimulus
- Youth unemployment, the Henan banking scandal, property sector weakness, and China’s Belt and Road Initiative lending are all pressure points
Problems are stacking up in China. Given that the art of investing always lies in judging what the crowd will do, and acting before the crowd does, investors may wish to reassess their exposure to the yuan and to Chinese assets in general, and make adjustments accordingly.
After all, when it comes to addressing exposure to trades that don’t look quite as attractive as before, “the first cut is the cheapest”, as they say.
Admittedly, China’s State Administration of Foreign Exchange (SAFE) sounds confident. “Judging from recent performance, although the dollar has strengthened further, the yuan’s stability among other major currencies has become more prominent as the domestic economy picks up,” SAFE spokesman Wang Chunying said last week.
The regulator also expressed confidence that overseas demand for yuan-denominated bonds would continue to increase over the long term.
In truth, investors should expect SAFE to exhibit confidence. It would be a seismic shock to markets if it were anything but confident. But whether investors share the forex regulator’s optimism is quite another matter. When capital is at risk, it pays to be open minded, and let’s be under no illusions – Beijing currently has its hands full with a number of economic and financial issues.
Beijing is sticking to its zero-tolerance Covid-19 policy, but it does come with economic costs. Nevertheless, investors could rationally infer that economic Covid-19 containment costs were built into China’s GDP growth target of “around 5.5 per cent” for 2022. Unfortunately, that target looks increasingly aspirational rather than attainable.
China’s economy only grew by an annualised 0.4 per cent in the second quarter of 2022, below analysts’ expectations of 1.1 per cent, lengthening the odds that China will hit its 2022 target.
“We’ll try our best to achieve good results this year,” Premier Li Keqiang said at a virtual dialogue hosted by the World Economic Forum on July 19, but importantly he also said, “We won’t resort to super large stimulus or excessive money printing to accomplish a high growth target. That will overdraw on the future.” Li is clearly not wedded to hitting 5.5 per cent at all costs.
There’s a lot to be said for such a nuanced approach but this stance should still prompt pause for thought among investors whose calculations may well, at least partly, have been predicated on the assumption that China would achieve its growth target.
It could be argued that, by itself, missing the target isn’t necessarily a deal-breaker for investors. And that’s a valid position. However, many other issues are emerging which, when taken as a whole, could adversely affect sentiment towards Chinese assets.
Youth unemployment, always a sensitive issue for Chinese policymakers, has been on the rise. Indeed, the jobless rate for those aged 16-24 reached a record high of 19.3 per cent in June.
Elsewhere, with regard the Henan banking scandal, an initial investigation by the Xuchang Public Security Bureau in Henan has confirmed that a criminal gang has exercised effective control over “several rural banks” in the province since 2011. 2011? Wow.
Depositors will be hoping for help from the Chinese authorities, but, either way, the scandal could damage wider domestic and international investor confidence in China.
As for the mortgage boycott that has been making headlines, it has been argued that these ripples, from the continuing problems in the property sector, do not represent a systemic risk for China’s banking sector. Maybe so, but that misses the point – it looks bad from an investor perspective.
Then there are China’s Belt and Road Initiative loans to countries whose financial circumstances have become so dire in the current global economic climate that local policymakers are looking for assistance from the International Monetary Fund.
IMF bailouts come with strings, as those who remember the 1997-98 Asian financial crisis will know. Debt restructurings that accompany IMF bailouts generally involve all creditors taking a haircut, as some portion of existing loans are written off.
Although Beijing is hardly going to embrace any such haircuts with enthusiasm, China’s economic heft remains sufficient for it to absorb the financial hits.
But Beijing’s inbox of problems is stacking up. Fear of missing out often informs investment in China but, sometimes, it’s the fear of staying put that prevails. This could be one of those times.
Author: Neal Kimberley is a commentator on macroeconomics and financial markets, SCMP