united kingdomen
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

Disclaimer

Please read this important information before proceeding further. It contains legal and regulatory notices relevant to the information contained on this website.

The information contained in the Website is NOT FOR RETAIL CLIENTS - The information contained in the Website is solely intended for professional investors, defined as investors which (1) qualify as professional clients within the meaning of the Markets in Financial Instruments Directive (MiFID), (2) have requested to be treated as professional clients within the meaning of the MiFID or (3) are authorized to receive such information under any other applicable laws. The value of the investments may fluctuate. Past performance is no guarantee of future results. Investors may not get back the amount originally invested. Neither Robeco Institutional Asset Management B.V. nor any of its affiliates guarantees the performance or the future returns of any investments. 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.

In the UK, Robeco Institutional Asset Management B.V. (“ROBECO”) only markets its funds to institutional clients and professional investors. Private investors seeking information about ROBECO should visit our corporate website www.robeco.com or contact their financial adviser. ROBECO will not be liable for any damages or losses suffered by private investors accessing these areas.

In the UK, ROBECO Funds has marketing approval for the funds listed on this website, all of which are UCITS funds. ROBECO is authorized by the AFM and subject to limited regulation by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request.

Many of the protections provided by the United Kingdom regulatory framework may not apply to investments in ROBECO Funds, including access to the Financial Services Compensation Scheme and the Financial Ombudsman Service. No representation, warranty or undertaking is given as to the accuracy or completeness of the information on this website.

If you are not an institutional client or professional investor you should therefore not proceed. By proceeding please note that we will be treating you as a professional client for regulatory purposes and you agree to be bound by our terms and conditions.

If you do not accept these terms and conditions, as well as the terms of use of the website, please do not continue to use or access any pages on this website.

I Disagree