By Jacob Mitchell, founder and chief investment officer at Antipodes Partners
Economic activity in China has been lacklustre this year, due to relatively soft credit data, continued weakness in the property sector and a worrying surge in Covid-19 infection rates – which prompted lockdown in certain key provinces.
Despite this, have been encouraged by a marked change in rhetoric and policy from the top echelon of the Chinese government, with suggestions monetary policy should be eased as required and moderate loan growth is needed to support the real economy.
In addition, the authorities want property developer risk to be managed, while regulation around internet platforms needs to be swiftly completed for the stability and healthy development of the platform economy.
Positive property reform agenda
Residential real estate development directly accounts for about 10% of GDP, and the slowdown continues to weigh on the economy. Gross property developer debt is about 30% of GDP, or around $4.5trn. If one-third needs to be restructured – a worst-case scenario – it equates to around 25% of the People’s Bank of China’s balance sheet.
By way of context, the Fed increased its balance sheet by nearly 120% in response to the pandemic. As the regulator targets lower leverage across the sector, highly geared developers will be forced to prioritise debt repayment over land banking and China’s property sector will consolidate around the larger quality players.
On a headline basis, urbanisation is high at 65%, but roughly one-third of these residents do not have household registration to live in the city – otherwise known as ‘Hukou’ – making it very difficult to acquire property. Adjusting for this, urbanisation is closer to 45%. The government estimates 300m citizens can be targeted with Hukou reform, along with policies such as lower deposits and mortgage rates, and rent-to-buy financing.
Signs of greater policy stability reduce the tail risk around Chinese regulation and reform. We remain of the view that policy makers are rapidly reaching a tipping point where reform must be balanced against economic health to defend the 5.5% GDP growth target.
Challenges call for stimulus
The crisis in Ukraine and risks to the global economy, a slowing export engine as consumption of goods in the West fades, and an increase in Covid-19 infection and lockdowns, heightens the need for China to stimulate. Add to this the 20th Party Congress elections at the end of the year, where President Xi Jinping will be determined to be re-elected.
Tax cuts have recently been announced targeting small and medium enterprises, which are a meaningful contributor to the economy, accounting for 80% of employment and 60% of GDP, but China has the scope to do more. Unlike the rest of the world, China does not yet have an inflation problem acting as a handbrake to stimulus.
China has a fiscal deficit of less than 5% of GDP, compared to the US at more than 11%, and government debt of less than 70% of GDP, against 120% in the US. We expect stimulus to focus on lower income consumption subsidies, decarbonisation investment and strengthening the social safety net via affordable housing, education and healthcare.
The key risks to recovery are that policymakers are too slow or too gradual to stimulate, that the risks in the property sector are not addressed, and the potential for more lockdowns as China attempts to gain control of Covid-19. China is in a challenging position with its zero-Covid policy.
Outbreaks are a meaningful headwind to domestic consumption and manufacturing activity, with the potential to create added constraints in global supply chains if lockdowns persist. Balancing this, China is trialling its own mRNA vaccine with a view to a rapid rollout and is also seeking to minimise the duration of lockdowns. We are following this closely given the implications for domestic and global economic activity and inflation.
Continuing confidence in quality
Our Antipodes global portfolios have approximately 13% exposure to China. Even though the Chinese economy remains in the middle of a slowdown we are encouraged by the change in policy rhetoric and increase in frequency of announcements around protecting the economy, stabilising the property sector, and reaching an end to the regulatory cycle.
Our exposure remains focused on dominant consumer franchises with opportunities to increase market share that will perform well in a rebound – such as travel, insurance, restaurants. We also are optimistic on leading platforms that are relatively better positioned from a regulatory perspective, like JD.com and Tencent, as well as very high-quality property related exposures.