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Robert Mann on What to Expect From China's Economy

Robert Mann on What to Expect From China's Economy

 
 

China’s recent economic growth surprised on the upside, but a credit rating downgrade by Moody’s, worries over Chinese debt, and a financial market crackdown by authorities have dampened sentiment. Pacific Money spoke to Singapore-based Robert Mann, senior portfolio manager at Nikko Asset Management, on China’s economy, stocks and the outlook for the year ahead.

Pacific Money: China’s latest gross domestic product (GDP) data was stronger than anticipated. Can we expect more of the same in 2017?

Robert Mann: The biggest surprise last year was how strong China was. However, looking at nominal GDP gives you a better feel for what’s happening than real GDP. In 2015, China’s nominal GDP was up by 6 percent, and over the past 12 months it’s up by 10 percent, so there’s been a major acceleration in nominal GDP.

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China had a big stimulus in late 2015-16 and we’ve seen that coming through in the data. So the first quarter GDP data this year showed things like that, such as excavator sales (used for construction) rising by 60 to 70 percent per annum, while house sales were strong.

From late last year, early this year though the government is now saying, “enough is enough, we don’t want growth to accelerate any further.” The word on everyone’s lips is stable, but it has changed its meaning. It used to mean [keeping] GDP growth as strong as possible to keep people happy and stave off risks. But stable seems to mean now avoiding bubbles, too much financial leverage that will cause problems later.

I think it is very clear that Beijing has recognized the path they were on was not correct. They know credit growth has to slow and they are worried about increasing leverage in the financial sector.

So we’re effectively at peak GDP growth now. We’re going to slow a little bit in the second half this year. The big question for markets is what happens next year. Once they get past the NPC [National Party Congress] will they allow growth to slow a lot or just a little bit? That’s still an open question.

There’s been plenty of talk about China’s high corporate debt levels and its shadow banking sector causing financial risks – what’s your view on this?

Last year I noted that China is not the risk, that growth is going to accelerate; we are fine until the end of 2017. On debt, you have to look what it is used for, whether it’s used on something that makes money, like a factory, or a subway chock-a-block with commuters, or something totally useless. Much of the discussion on debt doesn’t focus on if it’s used to build good things or bad things. The focus on only the debt can thus be a bit misleading.

The bulk of debt in China is not government or household debt. It’s corporate debt, but not private sector corporate debt; it’s SOE [state-owned enterprise] debt. This is effectively government-owned and government-related debt and people who have lent it assume the government will pay it back. And because the government balance sheet is still strong I am not worried by the debt in the next year or two.

Over the last year there has been a lot of growth in mortgage debt. House prices are strong so there’s not an issue there. There has been a big growth in market speculation, so the important thing recently is clearly a recognition that bad things are starting to happen in the financial sector and they are cracking down on it. You have a new guy in charge of the China Banking Regulatory Commission [CBRC] who is coming out with a lot of things to do.

They have arrested the head of the China Insurance Regulatory Commission [CIRC], some of their insurance companies have gone on massive binges overseas. So two of the heads of key regulatory bodies have changed.

There’s a big crackdown on speculation and arbitrage and other risky behavior in the financial sector. This is like a tightening of liquidity. Rates have gone up a bit, but if you’ve got a lot of regulatory things happening you spend less money — if you’re a bank, you’re going to lend less money; people who could get money before now can’t.

In some ways it’s pretty impressive that they’re prepared to address this. They have identified the issue and are getting in there to fix it, whereas in most other countries they wait until there’s a major problem and a blow out before starting an investigation.

Looking at the upcoming NPC – would you assume that reform efforts will be delayed until after the Congress for the purpose of stability?

They want stability going into it… having said that, the financial sector regulation is reform going on now… but the state-owned enterprises [SOEs] are the hardest of the lot.

On my recent visit to Beijing, they were talking about a five-step plan to bring debt under control. Number one is to reduce everyone’s expectations for GDP growth so we don’t invest too much; the second was to slow the rate of credit growth to GDP; third, get the private sector to do the investment; fourth, deepen and broaden the capital markets so the private sector can get the funding it needs; and fifth, have more proper debt restructuring measures in a market-oriented way.

Reforming the SOEs is really hard. They’re big bureaucracies and people fight change, so let’s make it easier for the private sector to do the investment. A lot of this bank reform is about getting the money to the real economy and not the financial sector, and if that happens the SOEs become less important to the economy. I think they’re going that way rather than the massive clean-up of the SOEs that some are looking for.

Looking at monetary policy, what are you expecting in 2017?

Rates have gone up a little bit. With the currency it’s clear they want stability; they wouldn’t mind a little bit of weakening on a trade-weighted basis against the U.S. dollar. So if the U.S. dollar is strong they’ll stay even with the basket; if weak they’ll probably depreciate against the basket.

They accept that on the capital account that it is right for Chinese to want to put more of their assets overseas, but what is unusual for an economy the size of China is how little foreign portfolio investment is in China.

So what they’re working on is making it easier for foreigners to invest in Chinese bonds and equities, they’re trying to get into the global market indices; they’ve now got Shenzhen connect as well as Shanghai connect.

So they want more foreign money in China, and when that happens they can let more Chinese money go overseas to balance it up.

The issues global fund managers have when A-shares come into their indices is how to invest in them. How do we cover these companies; they don’t have reports in English. This will become an issue quicker than many people thought, after the sharemarket volatility of a year and a half ago.

On fiscal policy, can we expect more stimulus to keep the economy on track before the NPC?

They don’t want a major slowdown before the Congress, so if the current regulatory efforts slow things too much they will tap on the accelerator a little bit, but with the Congress just six months away they can’t do much more.

Looking at Chinese stocks, are there any sectors or companies you currently favor?

We’re overweight China…What is interesting is a year ago the Chinese were more confident in the Chinese market than the foreigners. That’s changed around a bit at the moment. The Chinese are more aware of these regulatory approaches inside China than the foreign investors, who are looking at the published GDP data, which is backward-looking.

But the companies that we look at are the private sector companies… an interesting statistic we were looking at was the three big internet U.S. companies Amazon, Facebook, and Google versus the three big Chinese internet companies, Baidu, Alibaba, and Tencent.

China has four times the population of the U.S., the Chinese market is closed to foreigners and the U.S. market is open, and yet the market cap of the big three Chinese ones is about 40 percent of the big three U.S. ones.

GDP per head in the U.S. is higher, GDP in the U.S. is higher overall but China has more scope for growth and catching up, and the Chinese internet companies are pretty inventive, as are the American ones.

Our general view has been that the middle-class consumption story is still intact. The sectors we look at have longer-term strong growth, fit with the demographics, and aren’t relying on changing government policy… We like consumer stocks, healthcare, tourism. It’s consumption inside China as people move into the middle class, as opposed to the old days when it was cheap stuff made to sell overseas.

There’s plenty of speculation about Chinese A-Shares getting admitted to MSCI indices – any view on this?

It will happen eventually. The Chinese government wants it; the MSCI says here’s what you need to do, so investors need to prepare for it. But initially the weighting comes in as quite low… but it forces foreign investors to start researching these companies.

Meanwhile, China’s recent foreign investment surge appears to have parallels with Japan’s binge buying during its bubble era.

China is trying to learn from Japan… and they would say that Japan didn’t see the problems coming. Even after the economy started weakening it took a long time for the authorities to act. That’s why China acting early is a positive… But if they try to keep growing strongly next year, if they don’t slow down, then the most likely outcome for China is more like Japan… a big build up of debt and then a slowdown.

If China doesn’t slow growth now, if it builds too much infrastructure like those bridges to nowhere, then you finish up with very low growth rates. So the bad outcome is China more like Japan, but they’re trying to learn from Japan, and that’s why we’ve got this regulatory firestorm happening in the financial sector at the moment.

As a result of this, should investors be getting used to slower Chinese growth rates?

Definitely… they’ve got major population size but not much workforce growth, so it’s coming from productivity. When you stand back, 5 percent or 4 percent growth, what’s wrong with that? Yes, China’s growth is slowing and as it slows it will be less commodity intensive. The future will be selling things to China but it will be middle-class consumption… whether it’s holidays in Australia, education for kids, rather than old-fashioned coal and iron ore. That isn’t the future.

So you’re bullish for services but not miners…

Yes… this is longer term. China started off with horrible infrastructure. They’ve built great infrastructure and housing, but they can’t keep on building at this rate without growth in population. So in the long term it’s all about services.

Any view on when China might hit its peak and start maturing?

GDP per head is still low… so there’s still a lot of catch up. It will be more like a 10-year transition if they can manage it smoothly.

Finally, how are you seeing the outlook for 2017 – obviously the NPC will be a big factor. Will Chinese President Xi Jinping consolidate power and turn to reform next year?

Clearly you can’t know what’s going to happen beforehand… but I think the key thing to come out is what the succession plan is. Will it be seven people on the central committee, will it be less; will the 68-year rule be broken by keeping on Wang Qishan [head of China’s anti-corruption agency].

At some stage in the next few months, the market is going to look past this and form a view on what’s going to happen in 2018 rather than trying to outguess the market on the NPC.

Asian markets appear risky right now with the threat of war on the Korean Peninsula. How should investors react?

War on the Korean Peninsula would be bad for everywhere, but North Korea has been an overhang for Asian markets for a long time… Geopolitical risk will affect all markets together so I don’t see it as a reason to invest or not to invest in Asia.

Asian earnings have been upgraded this year, the first time in a number of years.  Valuations were cheap at the start of the year but are still reasonable, especially compared to the U.S. and Australia.

Global growth is a bit better than it seemed a year ago, but in the long-term context you want to invest where the growth is, and the real story of the last 10 to 15 years has been China’s emergence. What’s the positive for the next 15 years — it will be India. India is remarkably like where China was 15 years ago; everyone thought China didn’t matter then… and when China entered the [World Trade Organization] it hardly registered on investors’ screens.

India looks now like what China was then – if [Indian Prime Minister Narendra] Modi can keep on doing reforms. They have the youngest workers in the world; I think 20-40 year-olds, the peak of the global workforce, a third are now Indian, and by 2025-30, nearly three-quarters of the increase in that age group will be Indian. They’ve got some top universities, they’ve got some issues obviously, but that’s where the opportunities are. On a 10-year view we’re excited about the changes in India, and on a one-year view we’re very happy with China.

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