The pace of growth in China is notching downward, but the country of 1.4 billion people, representing one-fifth of the world’s population, still is expanding its economy as the emphasis shifts toward consumer-driven industries.
China’s gross domestic product (GDP), almost US$11 trillion and now the second-largest in the world, is expected to grow by 6.3%-6.7% in 2016 by most forecasters, including the International Monetary Fund and the World Bank. Although China’s GDP growth will be healthy by global standards this year, growth may be the slowest for the country in a quarter of a century. However, China’s economy is twice the size and much healthier than it was a decade ago.
“We expect slower growth in China to be the new norm, and it could move down to 5%-6% in the next few years,” says Catherine Yeung, equities investment director with Fidelity Investment Management Ltd. in Hong Kong. “[Growth} will be better quality and more diversified than in the past.”
China faces challenges on several fronts. Extreme volatility in domestic stock markets in 2015, and strong measures taken by the government to quell it, have reminded global portfolio managers that China is still an emerging market and could hit more stumbling blocks on its way to financial reform. China’s population still regards stock market investing as highly speculative, preferring hard assets such as real estate; thus, most households have been relatively insulated from the gyrations of stocks.
The renminbi was allowed to slip by roughly 2% against the U.S. dollar (US$) after the 2015 stock market plunge, and the renminbi could decline further as it moves away from its soft peg to the US$ to float more freely. There is a risk that rising U.S. interest rates could attract capital to the larger, more established U.S. financial markets at the expense of China’s markets.
Another potential problem is the growth of corporate and government debt. China’s banking system, as well as the “shadow banks” that offer private sources of credit, are overextended; a lot of bad loans are thought to be lurking beneath the surface.
Other risks facing China include a steep decline in property prices that could force developers and banks to deleverage and curtail real estate investment, and an increase in bankruptcies in infrastructure-related industries such as steel and cement that now are suffering from overcapacity.
“Eventually, the non-performing loans will come to light and China will need to undergo a banking reorganization. But, for now, [China’s banks] are adept at pushing the problems around the system,” says Nick Scott, head of Asian equities at I.G. Investment Management (H.K.) Ltd. in Hong Kong and portfolio manager of Investors Pacific International Fund, which is sponsored by Investors Group Inc. of Winnipeg. “I’m not a big fan of growth just for the sake of a higher GDP number. It needs to be healthy, profitable growth. Previously, a lot of growth came from corporate overspending and large, capital-intensive infrastructure projects. China needs to focus on better allocation of capital.”
The good news is that China is in a position to work a variety of levers to keep its economic pot boiling, including lowering of interest rates further or dropping the required reserve ratio for banks.
Another part of the economic plan is the development of “One Belt, One Road,” a government project to open up trade in markets accessible by land and sea in various parts of Eurasia, and to make up for China’s exclusion from the U.S.-led Trans-Pacific Partnership trade agreement.
The China Caixin manufacturing purchasing managers’ index stood at 48.3 in October – below the 50-point level, which separates economic expansion from contraction, but still highest level since May. Retail sales in China increased by 10.9% year-over-year in the third quarter of 2015, according to China’s national statistics bureau, indicating strength in consumer spending on goods and services, which now account for 58% of China’s GDP.
Says Chuk Wong, vice president of 1832 Asset Management LP in Toronto and lead portfolio manager of Dynamic Far East Value Fund (sponsored by Bank of Nova Scotia): “The decoupling from the old, export-driven economy to the new, domestic-driven economy will continue.”
Most fund portfolio managers, including Scott and Mark Lin, vice president of international equities with CIBC Asset Management Inc. in Montreal, are finding investment opportunities in the new economy, especially in health care, education, environmental improvement, transportation, high-end manufacturing and e-commerce. Both Scott and Lin (the latter manages CIBC Asia-Pacific Fund) like Baidu Inc., China’s biggest search engine and the country’s equivalent to Google Inc. Both portfolio managers also favour Tencent Holdings Ltd., which manages a social media website and chat service similar to U.S.-based Facebook Inc. In addition, Lin likes Alibaba Group Holding Ltd. and Jingdong Mall Inc.(a.k.a. www.JD.com), the domestic giants in online retailing.
Wong favours Shanghai-listed Kweichou Moutai Co. Ltd., producer of a potent alcoholic beverage called Moutai. Large-scale production of this drink, which is made from sorghum, originated in the 1600s during the Qing dynasty.
Although there are some concerns about the overheated Chinese real estate market, Wong says, prices are stabilizing in Beijing and Shanghai. He likes China Vanke Co. Ltd., the largest property developer in China.
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