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China's new economy takes root

China's new economy takes root

16-04-2019 | Insight
The Chinese economy is currently experiencing a downturn and we believe it will hit rock bottom in the second quarter. The recovery is likely to take place in the second half of the year due to last year’s government policy steps, says Victoria Mio, CIO at Robeco China.
  • Victoria  Mio
    Victoria
    Mio
    CIO Chinese Equities

Speed read

  • Markets are in the midst of recovery on the back of stimulus measures
  • Economy is on a rebalancing track, with services claiming a larger share
  • The MSCI A-share inclusion offers significant investment opportunities

We expect the stimulus measures to support equity markets. The ongoing rebalancing of the Chinese economy has brought new themes to the fore. Consumption upgrade, technology and innovation are set to create multiple new opportunities for investors. Also, the MSCI China A shares inclusion is offering access to significant long-term investment opportunities.

Growing opportunities in Chinese A-shares

The inclusion of Chinese A-shares in the MSCI Emerging Markets Index that took place last June is a landmark step for China’s integration into global markets. It is expected to boost investors’ interest in Chinese firms and to enable a large amount of capital to flow into the onshore Chinese market. The China A-share market is the world’s second largest equity market after the US.

After the initial inclusion, MSCI upped the proportion of A-shares from 5% to 20%, which will support the renminbi. Furthermore, the inclusion is expected to facilitate the further development of China’s capital markets. Full inclusion will most likely take five to ten years, depending on how much progress is made in terms of market accessibility. The A-share market offers broad exposure to China, and its correlation with the global equity markets is currently still low. Because it is in an early stage of development, it provides significant opportunities for active managers.

Rebalancing of the economy

China’s consumption is seeing a slowdown and an upgrade at the same time. Its structure is changing as the country’s middle class continues to grow, with rising spending power due to higher wages. Young adults are spending money on entertainment and innovative products. A growing group of aging Chinese are spending more on services, such as financial services and health care. In short, China is witnessing the emergence of a ‘new’ economy that is driven by these sectors. At the same time, the share of the ‘old’, production-oriented economy will shrink even further. The ‘new’ economy currently makes up over 55% of the MSCI China’s market cap. The themes related to consumption upgrade, and technology and innovation offer access to investment opportunities.

The ‘new’ versus ‘old’ share of the economy in China

Source: MSCI, BofA Merrill Lynch Global Research, FactSet, Bloomberg, as of September 2018.
The rising ‘new’ economy also means that China intends to become a quality rather than quantity manufacturer. For example, China already has the world’s largest robot market and the government is actively promoting the robotics industry with tax reductions and special R&D funding. It also has the largest electric vehicle (EV) market. Innovation will be one of the key growth drivers as China has become the second-largest R&D spender in the world.

Trade dispute: parties appear to be close to settlement

In 2018, the clash of Xi’s ‘China Dream’ and Trump’s ‘Make America Great Again’ has caused turmoil in the US-China relationship. The two parties currently look to be resolving the trade dispute. China and the US are in the final stages of their negotiations, and the deal might happen soon as settling the dispute seems to be in everybody’s interest.

In the run-up to this deal, a number of issues remain outstanding, including market access, intellectual property, the currency exchange rate and a verification mechanism for enforcing commitments. The US is insisting on such a mechanism, and the possible use of punitive tariffs. Mio does not expect the trade dispute to escalate.

Markets revive on the heels of policy stimulus

Following the lows of last October, China’s markets are currently beginning to recover with corporate earnings bottoming out. Last year the government implemented several policy steps to stimulate China’s economy on various fronts. At the macro level, China has shifted towards looser monetary policy and more expansionary fiscal policy. In order to facilitate the ongoing trade talks, China has stepped up efforts to attract foreign capital by widening market access, and opening up the financial sector.

The government also took steps to ease capital constraints for big banks, which has boosted loan growth. It is also in the process of introducing tax cuts, including a recent three-percent VAT cut for a group of industries, with more tax cuts to follow. The government will also continue to issue special bonds to fund infrastructure projects.

We expect the stimulus measures to boost consumer confidence and corporate earnings, and support Chinese equity markets. A resolution of the ongoing trade dispute between the US and China looks highly likely. This dispute is expected to be less of a driving force for markets going forward.

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