China — the swing factor in global growth

12/04/2019

Download

​Jennifer James, Lead Analyst within the Emerging Market Debt team, looks at the importance of China both for developed and emerging market growth.

If you had to pick between two economies, the Netherlands and Saudi Arabia, which would it be?

Why the question? Well, at the second session of China’s 13th National People’s Congress that concluded in March 2019, Chinese annual economic growth (real gross domestic product) was downgraded from 6.5% to 6.0-6.5%. To get a sense of what those numbers mean, growth of 6.5% adds an economy about the size of the Netherlands to China’s existing economy, while growth of 6% adds one about the size of Saudi Arabia1. Whichever way you look, those are big figures. Only the US, when it is firing on all cylinders, comes close.

Piece of the pie

Figure 1 shows the percentage contribution to global gross domestic product (GDP) of the US, the eurozone, China and several emerging market countries. The first thing to notice is that there is an inverse relationship between the eurozone and the US. Such was the size of these two economic powerhouses that when one was outperforming it tended to push down the relative weighting of the other. What is clear is that since its ascendancy 30 years ago, China has been taking share away from both the US and the eurozone as evidenced in their lower peaks. In fact, the International Monetary Fund predicts that by 2030, China will overtake the US to become the largest economy in the world2.

Selected countries and regions share of global GDP (%)

Source: Bloomberg, World Bank GDP in current USD, latest available figures to end 2017.

For Europe, this competitive threat is less disconcerting: it is a long time since a single European country held top spot, but for the US — the world’s existing economic hegemon — it is a source of wounded pride and helps explain why the US has engaged in a trade stand-off with China.

Borrowing slogans

Should investors fear an escalation of the US-China trade war? For all the posturing, neither side wants to escalate the current spat. First, the US may have an unpredictable leader but there is an election in 2020 and President Trump will not want to face the electorate with a downturn in the economy. In 2018, the US’ trade gap with China reached a record high despite tariffs on US$250 billion of Chinese goods, so it is questionable whether the tariffs are having much effect other than raise prices for US consumers.

Second, any escalation of the trade war would see China borrow the ‘America First’ slogan and orientate it to ‘China First’, which would translate into support for domestically-focused Chinese companies. China is not short of firepower to shore up demand. The latest Congress saw VAT cuts announced (3% off the manufacturing rate and 1% off the construction and transport rate) that is part of a RMB 2 trillion (US$298 billion) package to cut costs for businesses and put money back in Chinese consumers’ pockets. This comes on top of recent cuts to the spread premium that local governments must pay to issue debt, making it easier for them to issue debt for infrastructure investment. What is more, unlike in the West, the monetary arsenal is far from exhausted, with China’s key policy rate (the major loan rate) at 4.35%, which has been held since October 2015, giving plenty of room to loosen policy with conventional interest rates.

High speed to high quality

More challenging for western economies is that China is intent on shifting its economic model up the quality scale. With more than 800 million regular internet users in 2018 according to the China Internet Information Center, it already has an internet base nearly three times the size of the US, allowing domestic companies to incubate at size before launching into the wider world. This domestic market size advantage goes some way to explaining why China has an equivalent of Facebook (Tencent’s WeChat) and Amazon (Alibaba), yet Europe, with its linguistic and cultural disparity, does not. Companies like Alibaba and Tencent have low levels of net debt and can provide investors with exposure to a sector with near-inelastic demand. The tech sector in China, however, is prone to policy changes, so while policy has allowed these companies to grow rapidly in the past, it could also be a headwind in the future.

Rapid development has come at a price as attested by the pollution and environmental degradation within China, but even here China is moving at speed. It is already the world’s largest producer of electric vehicles, with sales exceeding one million vehicles in 2018, and a new initiative (new energy vehicle credits) launched this year will mean that car manufacturers will be penalised unless they meet low emission quotas or buy credits off manufacturers that do. It is literally a carrot and stick approach to changing behaviour.

Command economy

This capacity to rapidly manipulate the economy is one of China’s great strengths. There is a strong political desire for stability — born of the preservation instinct of the ruling Communist party — so if the authorities proclaim 6% growth, then that is what they will aim to achieve. Yes, the data may be suspect, but naysayers have been decrying China for years, yet the country continues tangibly to deliver.

It is worth remembering that China has deliberately been trying to deleverage the economy in the past two years. Coupled with western countries removing some of their policy accommodation, some decline in GDP is to be expected and this is showing through in the data as seen in Figure 2. The Chinese authorities have only latterly begun to relax some of the tighter policies so with the usual time lag between these initiatives and it translating into growth, conditions in China and the rest of the world may get worse in the coming months before they begin to improve. This is reflected in weakness in economies that have a high beta with Chinese growth including Australia, Germany and emerging market commodity suppliers.

Figure 2: China nominal GDP, money and financing (% change year-on-year)

Source: Thomson Reuters Datastream, 31 January 2010 to 28 February 2019. M1 is narrow money. Total social financing (TSF) is a credit and liquidity measure that reflects total funds provided by China’s domestic financial system to the private sector of the real economy.

Chinese banks play a unique role in implementing growth targets. The central bank has been cutting the reserve requirement ratio (RRR) and the market expects several more cuts this year. The effect of the RRR cuts is to allow the banks to have more capacity to lend, essentially putting more money into the system. Banks like Bank of China, China Construction Bank, ICBC and Bank of Communications are considered ‘pillar banks’ by the government. Although these banks have partial listings, they are effectively controlled by the government. As such, these banks have strong balance sheets, high coverage ratios and a managed bad debt balance.

A lot of attention has focused on the Chinese government seeking to slow the property market but this has been directed at speculative buyers. The government is still keen for urbanisation to progress, ie, first-time buyers moving from the land into towns and cities. This is not for altruistic purposes but to encourage more work and economic development: city workers who buy houses help support infrastructure and consumer spending. The authorities are cutting rates to promote this and have delegated housing to the provinces.

We view the bonds of property developers as an area of value. Some 8.1% of the JP Morgan Corporate Emerging Markets Bond Index (CEMBI) Broad Diversified is China (which is investment grade rated) but Chinese property developers, which represent 1.7% of the index, are mostly high yield. With around 30 issuers in this space, we prefer large- and mid-scale developers in Tier 1 and 2 cities (these are the larger cities). In particular, we like the builders in the Greater Bay Area (GBA), a megalopolis that links Macau and Hong Kong with southern coastal cities that has been targeted as a growth area for finance, trade, shipping and tech/innovation. Builders with high exposure to the GBA include Agile and Logan.  Agile 2021 bonds were issued at 8.50% yield in July 2018, and these bonds are now yielding 5.6% yield to worst (Bloomberg, as at 21 March 2018), reflecting the company’s deleveraging, strong order backlog, and an improvement in bond technicals. We believe value remains in this space, with the bonds offering strong carry with upside potential. For investors concerned about the geopolitics of trade wars, Chinese property is a domestic growth story that is nearly immune from the machinations of the trade negotiations.

Supply chains

More globally, China remains pivotal for many other emerging economies. While China is a large country, its appetite for resources means its reserves to production ratios for key commodities are quite low. Instead, it relies on imports for many commodities, existing in a symbiotic relationship with the wider global economy. This creates opportunities for many commodity producers such as Brazilian soybean and meat farmers, iron ore producers from around the world and oil/petroleum product exporters. Meanwhile, surplus Chinese savings, together with a desire to secure global supply chains with other countries has made China a major international creditor. For example, within the continent of Africa, seventeen countries now owe between 5% and 25% of their GDP to Chinese banks (IMF staff estimates, 2017). This is likely to deepen as China pursues its Belt and Road Initiative, which seeks to enhance connectivity.

In our view, the global slowdown is symptomatic of the two leading economies — the US and China — having tightened policy in the last two years. The pendulum may now have swung as far as it can in the tightening direction, with policy pausing or moving back towards easing mode. Ultimately, China will do whatever it takes to meet its growth targets and that should be supportive for the global economy.

 

1Source: Janus Henderson using World Bank national accounts data, GDP current prices USD for 2017.
2Source: IMF, People’s Republic of China, Article IV consultation, 26 July 2018

 

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

For promotional purposes.


Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Horizon Emerging Market Corporate Bond Fund

This document is intended solely for the use of professionals and is not for general public distribution.

The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Any investment application will be made solely on the basis of the information contained in the Fund’s prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the Fund’s prospectus and key investor information document before investing. A copy of the Fund’s prospectus and key investor information document can be obtained from Henderson Global Investors Limited in its capacity as Investment Manager and Distributor.

Issued in Europe by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier). We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Past performance is not a guide to future performance. The performance data does not take into account the commissions and costs incurred on the issue and redemption of units. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change. If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

The Fund is a recognised collective investment scheme for the purpose of promotion into the United Kingdom. Potential investors in the United Kingdom are advised that all, or most, of the protections afforded by the United Kingdom regulatory system will not apply to an investment in the Fund and that compensation will not be available under the United Kingdom Financial Services Compensation Scheme.

Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. Key Investor document is also available in Spanish. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Singapore Representative Janus Henderson Investors (Singapore) Limited, 138 Market Street, #34-03 / 04 CapitaGreen 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent. RBC Investor Services Trust Hong Kong Limited, a subsidiary of the joint venture UK holding company RBC Investor Services Limited, 51/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong, Tel: +852 2978 5656 is the Fund’s Representative in Hong Kong.

Information on this document is on Janus Henderson Investors’ best endeavours.

Specific risks

  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • The value of a bond or money market instrument may fall if the financial health of the issuer weakens, or the market believes it may weaken. This risk is greater the lower the credit quality of the bond.
  • Emerging markets are less established and more prone to political events than developed markets. This can mean both higher volatility and a greater risk of loss to the Fund than investing in more developed markets.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

Risk rating

Share

Important message