While China’s critical importance to the outlook for markets and the global economy is widely accepted, investors’ focus has understandably shifted of late to the pandemic and upcoming US election. But we shouldn’t overlook developments in the world’s second-largest economy, so here we highlight seven key points in our thinking about the country.
Strikingly, China’s economy is back to the pre-virus output path after contracting by 10% in the first quarter. Growth for the whole year should, we believe, amount to 2%; this would make China one of the few economies to expand this year. The relatively fast recovery from the virus is attributable to an ‘eradication’ strategy as opposed to the West’s ‘suppression’ strategy. When China lifted its lockdown, daily infections were in double digits. By contrast, when Germany lifted lockdown measures, daily infections were around 650.
China’s policy response to the pandemic has been relatively muted compared with other countries. Fiscal stimulus amounted to 4% of GDP, compared to 12% in the US and a world average of 8%. Credit growth – the key metric to gauge the monetary stance – has been even slower, accelerating by two percentage points, a far cry from the 15 percentage points after the Lehman crisis. The stimulus was directed at companies, not households.
We expect China’s economy to keep slowing very gradually over the next five years (possibly to 5% by 2025). This is due to a significant credit overhang, an ageing population and the plateauing of Chinese global market share. That said, we remain confident about China’s long-term growth prospects: the key to development is industrialisation, a process that China has figured out, in our view.
China’s debt build-up since the financial crisis has been unprecedented for any large economy. But, in contrast to a large (but shrinking) group of investment professionals, we don’t see this as a harbinger of a financial crisis. China’s debt is not owed to foreigners. Instead, most debt is owed by state-owned enterprises (SOEs) to state-owned banks, in effect shifting money from one pocket to another. Coronavirus presented a stress-test of epic proportions which China, despite all of its debt, passed with flying colours.
Most misconceptions about China are grounded in a developed-market perspective that is overly concerned with efficiency. But, at China’s level of development, learning how to master cutting-edge technologies is much more important. To give an example, many investment professionals are concerned about loss-making SOEs. But, if you want to learn how to produce world-beating trains, you need to be prepared to make losses. It is this long-termism that we believe is behind China’s success.
Role in the world
China now accounts for 16% of world output in US dollar terms and for one-third of world growth. Its export market share stabilised around 13% in 2013, after huge gains following its accession to the World Trade Organisation in 2001. Since then, with China experiencing slower growth and being more circumspect of large stimulus, the commodity supercycle ended. This hurt emerging markets. The relocation of industry out of China as a result of the trade war has not been pronounced so far, in our view due to the lack of alternatives and the pull of its internal market.
Under President Xi Jinping, we believe China has moved further away from Western political thought as evidenced by greater surveillance, the weakening of the rule of law, and the embrace of lifelong leadership. This has contributed to the reassessment of China as a rival in the US and Europe. China’s foreign policy has also become more muscular, even if its ambitions haven’t generally extended beyond its immediate neighbourhood so far. Here, though, a clash with the US in the not too distant future looks to us to be increasingly likely.
China continues to play a major role for investors on two fronts. Firstly, we believe the most important theme in geopolitics is this emerging rivalry between China and the US. It will shape the world like the Cold War did in the 1960s and 1970s and, in our view, will cause moments of volatility for investors.
Secondly, China’s economic growth trajectory is crucial for the economic well-being of the world as Chinese growth has contributed around one-third to global growth over the past 10 years. In this respect, we believe the world – and especially emerging markets and commodity markets – will benefit from Chinese economic might.