Blue Paper Revisit: Why we are still bullish on China
We are more confident thatChina will be able to achieve a near-stabilization of its debt to GDP by 2H19 and will attain high-income status by 2025, two years earlier than we initially expected. Despite its strong performance year to date, we expect MSCI China to continue to outperform EM over the cycle.
What has been driving the improvement in China’s macro outlook? Can this improvement be sustained? Are there new emerging risks we should be mindful of? Are you still bullish on China? These are some of the key investor questions that we have received since the publication of our February Blue Paper: Why we are bullish on China.
Our view in February was that China will be able to avoid a financial shock; the worst of the debt/disinflation cycle is behind us, and that China will make progress on its key transitions, achieving a high-income status by 2027. In this Blue Paper revisit, we document the progress that China has made and have found that, overall, the progress has been better than we expected as:
Policy tightening and related financial sector clean-up policies have helped to control financial risks.
Producer prices have decisively left deflation territory.
The corporate sector has begun to delever.
The pace of increase in overall debt to GDP has moderated to 4% points so far in 2017, as compared to the cumulative 42% points over both 2015 and 2016.
Meanwhile, consumption growth continues to outpace investment growth, services sector growth has remained strong and China continues to make inroads on high value-added economic activity.
To be sure, there are still risks on this journey. While markets have performed well this year and investors have reduced their underweight positions in China, there remains some skepticism over whether this improvement can be sustained.
There are three key concerns that investors have:
First, investors contend that China has only managed to slow the pace of increase, but that debt to GDP is still rising.
Second, there are concerns that as policymakers tighten to slow housing sales and address the rapid rise in household debt, this could cause a sharp adjustment with an attendant impact on growth.
Finally, whether the policy momentum on supply-side reforms will be maintained is also an area of concern.
While we share these concerns, our view remains that China will be able to navigate these challenges and continue to move towards becoming a high-income economy. Indeed, our confidence in our thesis has increased over the past few months considering the better-than-expected progress thus far and the continued strong emphasis on ensuring “sustainability” of growth.
In sum, we think that:
Debt and inflation dynamics will continue to improve. While headline producer prices will moderate due to base effects, we don’t expect a return of producer price deflation.
The pace of increase in the overall debt to GDP will moderate significantly to just 3% points annually from 2017-22, which would be a significant improvement from the 16% points annual average increase from 2012-16.
China will also be able to cross the World Bank's high-income threshold of US$13,700 and attain a high-income status by 2025, two years earlier than our initial forecast of 2027.
As China makes further progress in its journey towards becoming a high-income economy, the increasing prominence of the private sector along with its higher ROE and lower gearing, will likely mean that MSCI China can maintain its long-run track record of outperformance versus the MSCI EM over the next 10 years.
