A ‘high-risk’ label on China investments may not be easy to dismiss
CHINA’S gross domestic product (GDP) growth has come in at 5.2 per cent for 2023, in line with the government’s official forecast. But no one is celebrating just yet. For one, growth data for 2023 benefits from a low base in 2022. So, while the pace seems respectable, it falls far short of what is needed to ignite foreign appetite for direct investments and the stock market. This is because, quite apart from cyclical issues, fundamental worries have cast a pall over longer-term growth. The International Monetary Fund expects China’s growth to slow to 4 per cent in 2024, and to slow further to 3.8 per cent by 2028. Likewise, Moody’s expects a decline in GDP growth to 3.5 per cent by 2028.
In fact, China has hardly caught a break since it began to ease its severe zero-Covid policy in late 2022. The much-awaited Covid bounce quickly diminished last year, and it has had to grapple with a litany of troubles: a meltdown in the property sector that has decimated private wealth; rising unemployment, particularly among youth; rising debt levels, and the spectre of deflation.
To be sure, there are no quick fixes and institutional monies have turned cautious. Late last year, Moody’s downgraded its outlook for China government credit ratings to negative from stable, even as it retained the “A1” long-term rating for China’s sovereign bonds. Investors have begun to put their funds into broader indexes that exclude China, which was once unthinkable.
Given the slower pace of decision-making among large institutions – traditionally seen as sticky money – a high-risk label on China assets may not be easily or quickly dismissed. A snowballing of outflows is likely to have profound implications for the China stock market. Already, its weighting in broader MSCI indexes has dropped. In Bloomberg’s calculation, China’s weighting in the MSCI Emerging Markets Index has fallen to 23.77 per cent, the lowest since 2017.
In a survey of pension and sovereign funds by the Official Monetary and Financial Institutions Forum, nearly 40 per cent chose India as the most attractive emerging market. Less than a quarter picked China. None of the funds said that they had invested in China because of a positive outlook for its economy or because they were expecting higher returns. Instead, 80 per cent invested because of China’s inclusion in global benchmarks. The regulatory environment and geopolitics were cited as deterrents by more than 70 per cent of survey respondents.
To be sure, investors are clamouring for more fiscal stimulus. Last year, China issued 1 trillion yuan (S$188 billion) in additional sovereign bonds for infrastructure and to build resilience in disaster areas. More recently, it is reportedly weighing the issuance of 1 trillion yuan of new debt with an “ultra-long” repayment period to fund projects in food and energy, among other sectors.
But there are still more persistent issues. The pace of recovery and restructuring in the property sector is likely to be slow, even though the government has indicated more support. Higher debt levels will weigh on consumer and business sentiment. More serious still is the demographic overhang of a population that is shrinking more rapidly than expected, clouding the prospects of long-term growth.
On the face of it, China’s equity valuations are attractive; stocks are trading at a steep discount to the MSCI World Index, for example. But while investors may profit from a quick, tactical bet, long-term monies would do better to hedge their exposure.
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