Is China turning a corner?

Since Chairman Mao proclaimed the People’s Republic of China in 1949, the nation has been on a journey to reclaiming its role as a dominant force on the world stage. In the COVID-19 era, China has faced stark new challenges, emerging as both the starting point of the virus as well as the strictest enforcer of related population controls, with travel restrictions in and out of the country finally easing in recent days. Against this complex backdrop, Chinese financial assets have been on a wild ride in recent history. But are things beginning to change?

The return of the prodigal superpower
As one of history’s great superpowers, China accounted for around a third of the global economy as late as 1820. However, its position on the world stage faded rapidly in the industrial age, with its dominance superseded by newly industrialised Western powers. Following a century or so in a comparatively meagre position, China’s modern trajectory to becoming the world’s manufacturing hub and its second largest economy has been rapid, if not without difficulties.

“Over the past few decades, China has played a pivotal role in the ‘globalisation’ of supply chains around the world.”

Thanks to its capacity for cheap, large-scale manufacturing, China emerged as a key exporter, earning the nickname ‘the world’s factory floor’. Meanwhile, Chinese financial markets, which were initially very slow to open up to outside investors, have now ballooned to make up a significant portion of the assets available to global investors in developing economies.

However, in very recent history, China has been irrevocably entangled with the COVID-19 pandemic. In late 2022, when most of the world had moved on to a more pragmatic phase of COVID-19 management, new outbreaks of the virus led China’s authorities to reiterate its zero-tolerance policy, announcing new lockdowns in major cities. Financial markets reacted badly to ongoing evidence of China’s uncompromising approach, predicting knock-on effects for economic activity, and the price of Chinese financial assets fell sharply.

Faced with yet another spate of severe lockdowns, a rare wave of protests broke out among Chinese citizens tired of this zero-tolerance approach to the virus. While the resulting crackdown from Chinese authorities was swift, these protests (perhaps combined with the financial market outcry) appear to have impacted the way COVID-19 will be managed in China in the future.

Aside from newly relaxed rules for travel in and out of China (beginning on Sunday 8 January), the threshold for future lockdowns has been raised materially (potentially consigning them to the past), and testing and quarantining rules will be relaxed. There are very valid concerns about high levels of COVID-19 at work in the country at present, although this was sadly inevitable amid China’s reopening. A fresh vaccination drive, focused especially on the elderly, is in the works. A recent study in the US has also suggested that the efficacy of the Chinese-developed vaccine could be better than had previously been reported, potentially offering rates of immunity comparable to Western-developed vaccines. All in all, this was welcome news for both the Chinese population and the global investment community.

An authoritarian state in a modern world
China is unusual among the world’s largest economies for its authoritarian political regime, with the country ruled by leading members of the Chinese Communist Party. President Xi Jinping has been in power for around a decade, and an amendment to the state constitution means that there is no longer any term limit on his presidency.

In 2022, Xi reshuffled the Communist Party’s leadership, replacing a number of senior figures with party members reported to be personally loyal to him. Financial markets appeared to react very badly to this news too, although investors may also have been responding to unfounded hopes that Xi’s announcement would also contain news of COVID-19 easing (which ultimately came later). The price of Chinese financial assets fell quickly, and businesses with a substantial proportion of international shareholders (such as ecommerce giant Alibaba) were especially hard hit.

It’s worth noting that Xi’s newly appointed senior leaders may have more than merely their loyalty to recommend them: they could also be seen as experienced and competent hands. For example, Li Qiang – promoted to become Xi’s de facto second-in-command – is at least partially responsible for the development of high-tech industries and financial and technological innovation in Shanghai’s ‘Special Economic Zone’. Li will reportedly lead a team of economists and administrators with significant international experience, who are committed to ongoing economic development and technological innovation. It may yet transpire that financial markets have more to gain from these new leaders than first anticipated.

What do developments in China mean for the global economy?
China may be entering a new phase of development on a number of fronts. The longer-term effects of President Xi’s committee reshuffle remain to be seen, but fresh ideas from these new promotions, combined with an increasingly pragmatic approach to managing the COVID-19 pandemic, has the potential to improve the economic growth backdrop.

Indeed, China’s rulers are committed to policies which will, at the very least, support economic stability into 2023. In November 2022, China’s regulators expanded a financing programme aimed at supporting bond issuance in the property sector, as well as issuing a 16-point plan to support the sector. The focus of policies laid out at December’s Central Economic Work Conference (an annual meeting which sets the national agenda for China’s economy) included further support for consumer spending and the technology sector.

For China’s economy, and the value of Chinese assets, this should be good news. In the very near term, under more relaxed COVID-19 rules, we could see a slight impact to the economy as virus case numbers rise. But over the longer term, looser rules, and new senior committee members with a growth mandate to fulfil should lead economic activity to pick up.

When it comes to pricing pressures, domestic inflation is currently very low (around 2%), but fewer (or less extreme) lockdowns could allow inflation to rise higher. Similarly, a boost to China’s economic activity could also create a boost for the global economy, which is in dire need of growth. However, it remains to be seen what this would mean for global inflation.

Are Chinese financial assets a good bet?
Chinese asset prices have been penalised at various points in 2022, but at the time of writing, we are seeing welcome signs of recovery. Within our investment strategies, two areas could be especially helped by ongoing positive momentum. The first is a position in high-yielding Asian bonds, which so far has responded well to new policies introduced to support China’s property sector.

The second is our position in a fund focused on internet and ecommerce in developing economies. This set of investments has substantial exposure to businesses in China, which are set to benefit from the economy opening up. Chinese asset prices can be extremely volatile, as the past year has shown. But, bearing in mind these risks, and mindful that no outcomes are ever guaranteed, we continue to see real potential in selective areas of Chinese financial markets. Against the right backdrop, 2023 could see China turn an interesting corner in terms of domestic policy change, economic growth, and financial market performance.

For more info: wealthandasset.handelsbanken.co.uk