China: Growth, debt and liquidity promise to capture the spotlight
2017 Investment Outlook series
Looking ahead in 2017, the Invesco Equity Investment team in Asia believes the focus of attention for the Chinese economy and equity markets will be on growth, debt and liquidity. We expect China’s policymakers to focus their efforts on near-term growth stability, with reforms taking a secondary role for now. Consumption will continue to be the growth driver. China’s debt problem will linger on, but we see no imminent risk of an economic blowout. We are seeing a shift in loan activity from corporations to consumers, which we see as a positive development for the economy. As for liquidity, the existing Shanghai-Hong Kong Stock Connect and the recently launched Shenzhen-Hong Kong Stock Connect will continue to enhance market accessibility from both north- and southbound channels. In particular, we believe that global investors in offshore Chinese equities will benefit from the strong liquidity in the southbound channel. In this piece, we will explore these three topics in greater depth.
Growth: Stable and resilient, driven by consumption
China’s policymakers have two main objectives: maintaining decent economic growth and pursuing structural reforms. In 2017, we expect China to put greater emphasis on maintaining growth, with less priority on structural adjustments (such as reforms and debt reduction), given that growth is still the most important element for China’s long-term stability.
We believe the government will enhance growth through targeted infrastructure spending, offsetting the slowdown in private investments. We also expect the government to remain generally accommodative in the property sector, given the significance of this sector to overall gross domestic product (GDP) growth. That said, property measures will be differentiated across the country, with selective tightening in cities that are perceived to be overheating, and supportive policies in less affluent and overbuilt cities.
Looking ahead, we expect growth to be stable and resilient, with consumption being the major contributor. We anticipate retail sales in China will maintain an annual growth rate of about 10%,1 supported by resilient wage growth. Disposable income per capita for the urban population grew in the range of 8% to 13% year-on-year2 over the past year, and we expect this trend to continue. In addition, we believe the consumption sector will continue to benefit from the rising demand in services. Ranging from hospitality, retail, financial services, health care, education and information technology services, we expect the services sector to be a key source of growth in the coming year.
Debt: No imminent risk, but it will take time to resolve
We will continue to monitor China’s debt condition closely. The overall debt is now 255% of GDP, compared to 150% 10 years ago.3 This surge was driven by excess gearing, or leverage, following the aggressive stimulus program in 2008. While we acknowledge that the overall gearing level is high, there are three reasons why we believe there is no imminent risk of a short-term crisis:
- China’s debt is mostly locally funded. This eliminates currency mismatches and systematic risks that could potentially be linked to foreign debts.
- Government and household debt remains low. Total government debt currently stands at about 45%. We estimate central government debt to be less than 20% of GDP — a comfortable level compared to major developed economies. Household-debt-to-GDP remains low at 40%, much lower than the 70% to 90% levels recorded in major economies.4
- The government has the balance sheet strength from the “asset side” to support the troubled corporate industries through its vast holdings in quality assets, its ownership in listed companies and its flexibility to gear up, if needed. We estimate state-owned enterprises (SOEs) represent around 50% of total Class A shares and have a combined market cap of around RMB 25 trillion (about US $3.7 trillion).
One positive development in the banking sector is the increasing penetration in household loans and the slowdown in corporate lending. Similar to the deleveraging process in an economy, rising consumer credit demand can help spur the economy while allowing time for troubled corporates to undergo restructuring and deleveraging. Also, household loans, particularly mortgages (backed with houses as collateral), have lower default risk than that of the corporates, and thus are considered better-quality loans. In our view, the banking sector’s loan book quality should gradually improve as the consumer loans rise over time.
Strong liquidity and market support for offshore Chinese equities
The Shanghai-Hong Kong Stock Connect program has opened up accessibility between onshore and offshore Chinese equity markets, without the need for QDII/QFII/RQFII quotas. The recently launched Shenzhen-Hong Kong Stock Connect will complete the system, and both programs will allow two-way investments between onshore and offshore markets, covering the majority of stocks listed on the Shanghai, Shenzhen and Hong Kong exchanges. We see this as an innovative approach that promotes higher market accessibility between the two markets without sacrificing control over capital flows.
The potential benefit for global investors from the increase in market accessibility via the Stock Connects is twofold:
- First, global investors in offshore Chinese equities should benefit from the abundant liquidity in the southbound route, which will also support the market. In October 2016, more than 50% of the southbound daily quota was used, and close to 20%5 of Hong Kong daily turnover was reached at its peak. In particular, the liquidity was attributed to the mainland flows, where mainland China investors’ accounts increased from 11% to 22% between 2012 and 2015.6 Looking ahead, the expectation for renminbi weakness, higher dividend yields and generally cheaper relative valuations in H-shares compared to A-shares are reasons for mainland investors to consider diversifying their exposure into offshore Chinese equities.
- Second, global investors can take advantage of the easy access to the onshore A-shares market via the northbound route. Both Shanghai and Shenzhen Connects will collectively cover 92% of the MSCI A-Shares Index by stocks or 97% by market cap.7 This is a significant development. Without the restrictive QFII quotas or reliance on A-share ETFs, investors will now have direct access to the onshore markets to invest in specific A-share stocks.
Conclusion
In 2017, growth, debt and liquidity will be in the spotlight for the Chinese economy and markets. While we closely monitor the macro developments in China, our focus is on stock-specific fundamentals. As active, bottom-up investors, we adopt a selective approach to investing in companies with sustainable leadership and competitive advantages. Companies we select for our portfolios share a number of common, qualitative features — competitive products or services, superior business models and solid corporate governance with clear ownership structures, as well as transparency and corporate access.
1 Sources: CLSA and NBS, August 2016
2 Sources: CLSA and NBS, August 2016. Quarterly year-on-year growth rate.
3 Sources: Bank for International Settlements and Invesco, as of September 2016. Data as of first quarter 2016.
4 Source: JPMorgan, September 2016
5 Sources: HKEX and Invesco, as of October 2016
6 Source: HK Stock Exchange Factbook 2015
7 Sources: MSCI, Factset, Bloomberg L.P. and Invesco, as of September 2016
Important information
Blog header image: Toa55/Shutterstock.com
Launched in November 2014, the Shanghai-Hong Kong Stock Connect is a securities trading and clearing links program that allows both international and domestic investors to make cross-border stock purchases between the Shanghai and Hong Kong stock markets.
Launched in December 2016, the Shenzen-Hong Kong Stock Connect is a securities trading and clearing links program that allows both international and domestic investors to make cross-border stock purchases between the Shenzhen and Hong Kong stock markets.
QDII stands for Qualified Domestic Institutional Investor. This scheme permits registered Chinese financial institutions to invest a limited quota of funds in foreign financial assets, including offshore-listed Chinese equities. On the other hand, global investors can access China A-shares through the QFII (Qualified Foreign Institutional Investor) and RQFII (RMB Qualified Foreign Institutional Investor) schemes. However, these schemes are available only to institutional investors who can fulfill capital and asset size requirements. Detailed submissions and preapprovals are needed for the mentioned schemes.
H-shares refers to mainland Chinese companies listed on the Hong Kong Stock Exchange. As of Nov. 1, 2016, H-shares are trading at a discount to A-shares for the dual-listed Chinese companies.
The MSCI A-Shares Index captures large- and mid-cap representation across China securities listed on the Shanghai and Shenzhen exchanges.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Investments in companies located or operating in Greater China are subject to the following risks: nationalization, expropriation, or confiscation of property, difficulty in obtaining and/or enforcing judgments, alteration or discontinuation of economic reforms, military conflicts, and China’s dependency on the economies of other Asian countries, many of which are developing countries.
Mike Shiao
Chief Investment Officer, Greater ChinaMike Shiao joined Invesco in 2002 and was promoted to Chief Investment Officer, Greater China in 2015. With over 23 years of industry experience, he leads the Greater China equities team and focuses on the Greater China equity strategy, covering the Hong Kong, China, and Taiwan markets.
Previously, Mr. Shiao was head of equities for Invesco Taiwan Ltd. He started his investment career in 1992 at Grand Regent Investment Ltd., where he worked for six years as a project manager supervising venture capital investments in Taiwan and China. In 1997, he joined Overseas Credit and Securities Inc. as a senior analyst covering Taiwan technology sector. Mr. Shiao also worked at Taiwan International Investment Management Co., as a fund manager and was responsible for technology sector research.
Mr. Shiao holds a bachelor’s degree from National Chung Hsing University, Taiwan and a Master of Science degree in finance from Drexel University, Philadelphia.
