EM corporate debt: Five takeaways from China’s education sector crackdown

by | Jul 29, 2021

Discussing China’s recent reforms, Ninety One’s Hong Kong-based portfolio manager, Alan Siow, outlines important considerations and potential implications for investors in the country’s corporate bonds.

The background

The State Council of China has announced aggressive reforms on the country’s private education sector, focusing on the providers of after-school tuition. In effect, the move will force existing companies in the sector to convert to non-profit institutions while imposing a general ban on the foreign ownership of such firms under the Variable Interest Entity framework (details at the end of this piece), with the latter potentially having wider implications for the Chinese technology sector. Here are five key takeaways.

1: Market reaction has been abrupt and spilled over

The release of the opinion paper announcing the reforms initially caused an isolated sell-off in the listed equities of the affected companies operating in the sector. However, given the wider backdrop of China’s policy moves in other sectors – such as the ongoing deleveraging push in the property sector – the sell-off then spread to other sectors.

As the opinion bore the stamp of the State Council (one of the highest authorities in China), investors began to question if the policy might be extended to other sectors, particularly those that also rely heavily on VIEs. As a result, the Chinese tech sector began to suffer. Finally, as some of the affected VIEs are also issuers of corporate bonds, fixed income markets were also impacted.

2: Beware sweeping extrapolation

We think the market has perhaps been somewhat hasty in extrapolating what is a very narrow opinion statement on a specific sector into a broader generalisation about the wider constellation of Chinese companies.

In our view, there is not yet enough clarity or detail in the opinion to draw the kind of strong conclusion that the recent market moves would imply – namely, that it amounts to a large-scale change in underlying economic arrangements.

To give credence to such fears, we would need to see clear evidence that the Chinese authorities are planning to expand the implementation of these measures more broadly across other sectors. Equally, as has been convention, we expect to see clarifying statements and remarks in the coming days and weeks that will provide details about the scope and likely timeframe for the implementation of this policy. This should help to reduce uncertainty and quell fears.

3: Keep up with developments, but keep things in perspective

While it is important not to overreact to developments, the opinion paper does reveal changing priorities at the highest levels of the Chinese administration that merit closer study and attention. Policy shifts of the kind being discussed currently have become an increasingly prominent part of the new fabric of Chinese policy, especially in the context of rising Sino-US tensions. Therefore, investors are right to be cautious.

However, it is hard to imagine that the Chinese authorities intend to indelibly undermine on a wholesale basis the business models of internationally competitive companies that are in many ways national champions and important vectors of Chinese growth and development. Yes, China may well be fine-tuning its approach to a market-based socialist economy in a way that allows more influence by the State, especially in the context of rising nationalism globally. But it seems unlikely that it is about to needlessly abandon the hard-won gains of the last few decades since it joined the WTO and global trading order.

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