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China against the grain: New economic model for growth

Publication Date: 04 Jul 2018 - By Market Mogul By Market M.

Environmental, Social & Governance Macro FX & Rates Multi Asset Fixed Income/Credit China


Chinese growth is slowing down from all points of view. This slowdown is especially affecting the development of bond investments, as confirmed by domestic data. Venture cutback has been prioritised and Chinese leaders have started to focus on sustainability. Cutting exposure related to the financial system is the foremost aim of the government. A growth in terms of quality rather than an “expansion at any cost” is the long-term strategy designed to achieve new goals from now.

A Concern for Investors

Although China is considered one of the most important worldwide drivers of growth, Chinese GDP increases have been overtaken by accruing credit dependent on investments financed through debt from the global financial crisis. The shadow banking system’s lever has always been the weak link in the Chinese universe.

Loans requested from non-bank financial institutions (NBFI) have grown enormously, from ¥7trn ($ 1.1trn) at the end of 2013 to ¥24trn ($3.77trn) by the middle of 2016. This massive level of debt has long been a major concern for investors. China is still a global power and its derailment would have a huge impact on the world economy, and especially bond markets.

Investments are Falling in Almost All Areas

Over the last six years, the credit-intensive investments have gradually decreased. Annual growth in manufacturing investments has declined from 31.8% in 2011 to 4.1% in October 2017. Even if the investments continued to grow at a rapid pace in terms of infrastructure, a further braking is expected this year.

The total growth of bond investments should drop from 7.2% in 2017 to a threshold of 6% with the start of deleveraging and government tightening measures. Many scheduled projects have been blocked by the central government, so a strong signal has been sent to local governments who have decided to contain debts and investments at the peripheral level.

Every Cloud Has a Silver Lining

It is necessary to stay optimistic despite these hard times. Services and consumption are currently affected by a growth trend responsible for almost 70% of GDP increases. An improvement in consumer consumption numbers has been seen, thanks to the new generation’s consuming desire. Consumption of information services, smart appliances, culture, tourism, health and training is on a massive upward trend. Disposable income levels will increase and a key role for GDP rising will be played by employment stability, a solid labour market and wage growth.

Getting Down to Brass Tacks

Real GDP growth remained at remarkably high levels, around 6.8% last year. It is partly due to a structural change towards consumption-driven growth, and partly to the positive effect of thriving global wealth. This bodes well for investors who are going to buy shares in the new economy, avoiding industries of the old economy such as mining and steel, instead focusing on those companies that will benefit from an economic turn toward consumption.

This means that the gap between debt and GDP will be set back significantly. Lowering financial risk is the Communist Party of China’s main goal for the next five years. And even if the target of real GDP growth for 2018 is 6.5%, this will no longer be an evaluation metric for local administrations, a factor that should contribute to the change from the bottom up.

Out of the Blue

The refurbishment of slums remains a growth factor, driven by the efforts of local governments. In terms of urbanisation, living space per person rose from 2 square meters in the 1990s to 41 square meters (equal to the Netherlands), while real estate investments will be reaching new highs in 2018.

In this way China’s paradigm shift could offer great opportunities for investors. It remains to be seen whether China will be able to completely remove the excesses of the past in terms of credit and reduce the imbalance of the debt-to-GDP ratio without affecting long-term growth. In a market economy, implementing the current strategy would be difficult, but the new “Chinese economic model” could be successful.

This post appeared first on The Market Mogul.


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