latamen
China flexes its policy muscles – but can they still do the heavy lifting?

China flexes its policy muscles – but can they still do the heavy lifting?

06-01-2022 | Monthly outlook
China’s muscle flexing to fix its problems is set to keep investors cautious until the domestic economy garners more growth.
  • Peter van der Welle
    Peter
    van der Welle
    Strategist SMAS

Speed read

  • Tough policy action aims to reduce inequality and counter populism threat
  • Domestic engines of growth have been sputtering amid real estate crisis
  • Increased signals of policy easing look promising for cyclical stabilization in H1 

The country has initiated several tough policy actions and launched its Common Prosperity program to tackle the main threats to both growth and internal stability. However, the jury is still out on whether these measures will prove effective, says strategist Peter van der Welle.

As the country’s influence extends far past its borders, the Robeco multi-asset team has been taking a neutral stance on both Chinese and emerging market equities in its portfolios, he says. 

“In 2022, China will likely be top of mind for investors, even disregarding the Winter Olympics to be held in Beijing in February,” Van der Welle says. “China as a single country has determined around 30-40% of annual global GDP growth in the recent decade, and it led the global economic cycle into recovery in 2020.”

Stay informed on our latest insights with monthly mail updates
Stay informed on our latest insights with monthly mail updates
Subscribe

Engines are sputtering

“However, in  2021, China’s contribution to global growth faltered on the back of a policy-induced deceleration domestically while developed economies caught up. China’s main domestic engines of growth – real estate, manufacturing and infrastructure – have been sputtering lately.”

“With the monetary and fiscal impulse expected to decrease in the West into 2022, the fate of the Chinese growth trajectory becomes all the more important for the global economy. Therefore, now more than ever, investors should ask themselves: ‘What is on Beijing’s 2022 wish list?’ as the new year is finally upon us.”

China’s economic power is so great that even minor wobbles in its growth trajectory affects other countries across Asia. Emerging market equities have underperformed relative to their developed world counterparts for the past few years, making them less attractive in a multi-asset portfolio.

Common Prosperity

One problem is that the growth in the country’s wealth has not been fairly shared among its 1.4 billion people, leading the government to introduce the Common Prosperity program. China is also seeking to improve welfare for the poorest to stave off any social unrest that threatens the regime.

“In terms of wealth inequality, Chinese society is largely on par with the US, with the richest 1% of households owning one-third of the country’s wealth,” says Van der Welle. “It is President Xi Jinping’s fear that if this inequality persists, it will erode the middle class.”

“This would lead to polarization and the rise of the kind of populism seen in the US, potentially challenging the Communist Party. The Chinese political establishment realizes that the country’s major problems are to be found at home, given a very high total debt-to-GDP ratio of 270%, an ageing population that is starting to gradually worsen the dependency ratio, and increasing environmental costs.” 

Implementation is key

To address these long-term challenges, the Common Prosperity program is concentrated around three troublesome sectors. “Implementation is key, and so policy makers have tightened the thumbscrews on sectors with significant concentrations of wealth and market power, notably the real estate, technology and education sectors,” says Van der Welle.

“For instance, the People’s Bank of China’s (PBoC’s) three ‘red line’ policies – a liability-to-asset ratio of less than 70%, a net gearing ratio of less than 100%, and a cash-to-short-term-debt ratio of more than 1x – amounted to forced deleveraging in the real estate sector. The most infamous casualty of this was Evergrande, which is now entering a debt restructuring process.” 

Hard to read the tea leaves

The question therefore arises as to whether the crackdown has worked, and whether investors could expect an easing of state interventionism in the corporate sector in 2022, which would bode well for Chinese and emerging market equities. 

“The evidence is inconclusive as it is hard to read the tea leaves in Beijing,” says Van der Welle. “The ongoing slowdown in housing sales and Chinese house prices from the crackdown hurts domestic consumption growth as the ’wealth effect’ is eroded.”

“There is historically a strong positive correlation between Chinese consumption growth and domestic house prices, as the largest chunk of household wealth is determined by real estate assets.”  

Don’t forget Covid-19

Meanwhile, the Covid-19 pandemic continues to ravage across the world, led now by the Omicron variant which has caused a new wave of lockdowns. 

“Given the zero-tolerance Covid strategy, and the evidence emerging about the ineffectiveness of the Sinovac vaccine to protect against Omicron (even after a booster), lockdown intensity could increase in China in the near term,” warns Van der Welle. 

“This could additionally suppress domestic demand, even with the Winter Olympics approaching. Chinese policymakers will have to show their agility and ability to slalom around all these downside risks to growth.”

Engineering a soft landing

All eyes will be on the response from the very top. “In order to burnish his credentials as a socialist party leader ahead of the 2022 Party Congress, President Xi will likely be determined to safeguard social stability by engineering a soft landing for the economy in the near term,” says Van der Welle. 

“Easing monetary policy through further cuts in the reserve requirement ration (RRR) and a bottoming out of the credit impulse in H1 2022, along with the use of fiscal stimulus and a loosening of housing regulations are the most obvious policy tools.” 

“The PBOC and the finance ministry have already expressed their commitment in late December to ensure stable growth by hinting on lower taxes and providing reasonable and ample liquidity.” 

But the jury is still out

So, will it be enough?  “Although it is increasingly likely that deleveraging, decarbonization and housing wealth deflation is going to take a backseat as we enter 2022, we remain in the wait-and-see mode,” says Van der Welle. 

“With geopolitical tensions with the US increasing (especially around Taiwan), the incentive for President Xi to bring domestic productivity wins forward in time by continuing his hard-handed interventionist policies is still there.” 

“The Common Prosperity program is not a momentary event. This leaves considerable uncertainty on the table for investors. The potential for Omicron to trigger extensive lockdowns in China around the Winter Olympics is another headwind.”

“Although China’s policy muscles have clearly been flexed, the jury is still out on whether they can still do the heavy lifting. “We remain neutral on Chinese equities and emerging market equities for now.” 

Subjects related to this article are:
Logo

Important information

The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).

This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.

This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.

I Disagree