Has anxiety over China gone too far?
By Jade Fu, Investment Manager at Heartwood Investment Management
Needless to say, the overwhelming source of fear in financial markets since August has centred on China. Investors have been quick to downgrade growth forecasts for this year and next, but we believe some of this anxiety may have gone too far.
Before the Global Financial Crisis in 2008, the Chinese economy was enjoying double digit annual rates of growth as it industrialised and became a key contributor to global growth. But most would agree that those levels were unsustainable over the long term. Moreover, not only would the annual rate of growth have to slow, but, importantly, the composition of growth would shift as it relied less on fixed-asset investment.
Today, even the most bearish of market forecasts see an economy growing at above 6% this year, and most economists are looking for a modest pick-up in growth in the fourth quarter of 2015. We have long held the view that China was unlikely to achieve the official forecast of 7% this year, but we continue to see an economy that is growing and not collapsing. There has been an overwhelming focus on manufacturing data disappointments in recent months, which has fuelled the bearishness among investors, but it should be remembered that China is running a two-speed economy as it rebalances towards domestic demand.
The services sector now comprises nearly half of GOP, according to the World Bank, and activity has been holding up well. In addition, retail sales growth is tracking a consistent annual pace of above 10%, which is supported by a stable labour market. Nevertheless, this is a painful adjustment for the industrial sectors of the economy and we expect the People's Bank of China (PBOC) to take further policy steps to support growth, especially as the corporate sector is highly leveraged. Economic fundamentals have deteriorated since 2008, although external indicators, such as foreign exchange reserves, the current account balance and external debt, are better placed than other emerging market (EM) countries.
The key question is whether the PBOC can achieve a managed slowdown, especially since its credibility has been tested in recent months with the interventions in the stock market and the surprise currency adjustment in August. While we acknowledge that the risk of a policy error has increased, our view remains that the PBOC has the capacity and intention to keep the renminbi stable, supported by China's huge foreign exchange reserve base. We expect. though, the renminbi to moderately depreciate over time. Moreover, despite the raft of easing measures since November 2014, China's policy rates and bond yields are among the highest globally, and there is room for further policy easing.
As well as central bank support. we also believe that government fiscal stimulus will be important to support those sectors under pressure, for example through higher infrastructure investment. And the government has scope to increase spending. Year-to-date public spending remains under budget, suggesting that government investment may accelerate in the fourth quarter to support growth. We expect that these factors – central bank policy easing and fiscal stimulus – should help steer the economy towards a soft landing.