Does China’s tightening policy hamper economic growth? In this edition of our China on-site series we try to answer this question and also look at China’s leading position in industrial innovation.
The Chinese government is tightening its monetary policy to rein in credit growth. This has raised some concerns about the potential dampening effect on economic growth. In our view, the Chinese authorities are very much aware of the balance they need to strike between credit growth management and economic growth.
Chinese interest rates have been rising since the start of 2017, as the People’s Bank of China (PBoC) has been raising money market rates. The PBoC’s objectives are to limit outflows as USD rates rise, and to counter the very high risk tolerance in local bond and money markets that has been pushing down yields and credit spreads. In December 2017, the PBoC raised the reverse repo rate, a short-term rate at which it borrows money from commercial banks, taking liquidity out of the system. We expect gradual further tightening of monetary policy.
We welcome the PBoC’s tightening measures, as it checks excessive corporate debt growth. Although it may have a mitigating effect on economic growth, we are not worried. GDP growth is likely to be 6.5% in 2018, after having amounted to 6.9% over 2017. As consumer demand is resilient (retail sales picked up to 10.2% in November from 10% in October), we expect consumption to remain an important growth driver in 2018. We also forecast robust 2018 earnings growth at 15% for the MSCI China index. Valuations are reasonable and we expect fund flows into both Hong Kong and mainland China stocks as active funds reduce their underweight in China. This combination of factors provides a good backdrop for China's equity markets in 2018.
Robotics and exponential growth in digitization will make factories smart, as they increase productivity, improve quality, shorten lead times for new products and require less energy to produce them. China is one of the global leaders in industrial innovation.
China is installing more robots than any other nation to compensate for an aging and more expensive workforce. Moreover, China is determined to move its vast manufacturing industry up the value chain. It added about 90,000 robots over 2016, a third of the global total, and this will increase to 160,000 in 2019, according to the International Federation of Robotics. The government’s current 5-year plan targets an increase from 49 robots per 10,000 manufacturing workers in 2016 to over 150 per 10,000 by 2020.
China is the second largest spender on Research & Development in the world. This is driven by two forces: first of all, Chinese entrepreneurship (the average age of listed companies’ chairmen is much lower than in other countries) and, secondly, support from government policies. Central and local governments offer tax reductions, special funding and other subsidies to industrial automation firms. This significantly increases profitability, leaving companies with more funds to reinvest in the business, and thus take the sector’s progress forward rapidly.
We expect robust demand for industrial robots in 2018, driven by strong industrial upgrade investment. As the graph above shows, upgrade spending outpaces overall manufacturing fixed asset investments (FAI). From January to August 2017, industrial upgrade investment grew 12.4%, 8.6% ahead of manufacturing FAI. Upgrading was 47% of total manufacturing investment. Robot sales from domestic suppliers are expected to show compounded annual growth of a stunning 40% from 2016 to 2020.
Although competition with foreign high-end suppliers is still limited, Chinese automation companies are catching up. For now, we find the best investment opportunities in the mid-end segment.
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