By Geoffrey Lunt
I am increasingly lonely. I am a China bull, which now makes me a very rare breed indeed. By that, I mean I have a much more optimistic view of the future for the country and the economy than the consensus and, perhaps most importantly, that there is a fundamental misunderstanding about the risks which really do threaten China and some of the implications for the global economy.
I am not so naïve as to think that these are not genuine threats to the continued benign growth environment, but I do think that it has become all too easy to jump onto the bandwagon with these same old hackneyed concerns over the Chinese property market, shadow banking system, regular banking system, 2014 economic growth, and the overall growth model.
A common worry concerns the government’s action to make the economy more modern and sustainable – one obvious example being the first corporate bond default in China which indicates the government’s wish to make the market to become the decisive factor in the price setting mechanism. The modest rise in credit spreads, which came as a consequence of investors assessing default risk more realistically, will cool credit growth in a way which should boost confidence in the system. Equally, the spikes we have seen in money market rates in China in recent months have been the result of the authorities reminding credit institutions that liquidity is not always going to be so abundant, and that their lending cannot become excessive.
So what are the risks to China? The greater risks are not that the economy is going to grow more slowly, but that it reaccelerates as a result of the government losing its nerve and easing back on its reform of the financial and economic system. China will not be able to finance its next growth phase, to change the model of its economy in the long run, nor tackle its deteriorating demography without the changes now being implemented.
The strength of the Chinese economy during the financial crisis was that it could direct financial assistance to the sectors which needed it most, unlike the capitalist model which in extremis can starve otherwise viable sectors of finance as everyone withdraws at the same time and wreaks havoc as a consequence. In this way, China is likely to lose its role as a stabilising influence on the global economy and become more vulnerable to the rest of the world. This will mean that global economic cycles will be more extreme. So in fact one of the risks of China becoming a more modern and open economy is that the world will become more volatile and correlated rather than idiosyncratic.
From an investment point of view, all this leads me to a firm conclusion. China has huge markets which are opening up to foreign investors, so opportunities will be abundant, but we need to be discerning. The recent divergence of different sectors and stocks in the Chinese equity market shows that a relatively flat market can still yield valuable returns, and the prospects of a more market-driven bond market means that diligent credit research is crucial to avoid defaults.
Investing in China is not going to be a discretionary option as its markets become increasingly important parts of global indices. To coin a cliché – China is now just too big to ignore. Meanwhile, if Warren Buffett is right in his assertion that we need to be brave when others are fearful and fearful when others are brave, then on that measure alone, there surely couldn’t be a better time to consider investing in China.
Geoffrey Lunt is director and senior product specialist, Asian fixed income at HSBC Global Asset Management
Comments