China – tackling the Evergrande crisis and striving for stability
Given the recent turmoil, Beijing will be aiming to stabilise growth in 2022. The risk of a further downturn has reduced. Although the economy may pick up in the second half of 2022, upside potential for the bond and equity markets remains limited.
In the second or third week of December each year, the Chinese government sets out its objectives for the economy in the following year. The Central Economic Work Conference then meets behind closed doors for a gathering of China’s political elite and leaders from its financial and banking sector. The watchword this year was ‘stability’, with the goal being for the Chinese economy to present a more stable picture in 2022. It has recently experienced significant turmoil. This was partly due to the government’s new strategy focused on ‘common prosperity’, the aims of which included capping the level of debt in heavily indebted sectors. One of the consequences, however, was the current crisis in the property market. Moreover, the strict zero-COVID policy continues to hold back domestic growth.
Politicians have not communicated a clear growth forecast since the conference. However, China is likely to start 2022 with a more pro-growth and growth-stimulating stance than at the beginning of this year. There should also be fewer of the regulatory surprises that have weighed heavily on the tech sector, for example, and really spooked foreign investors. It remains to be seen whether the Chinese economy has now turned the corner, but early signs of stabilisation are emerging. The country’s government and central bank recently took steps to stabilise macroeconomic conditions. This has reduced the risk of a further downturn.
The new normal at around 5 per cent
Nevertheless, Union Investment’s economists do not anticipate that China will return to its typical pre-pandemic growth rates of around 6 per cent. The economy has simply become too big and the starting position too high to be able to continue expanding at this pace. The Union Investment economists predict that gross domestic product (GDP) will grow by around 5 per cent in 2022, which is somewhere in the middle of the broker estimates.
Growth shifts to 2022
Furthermore, Union Investment’s experts do not expect China’s zero-COVID policy to end before the party congress in October/November 2022. This is likely to hold back growth in areas such as consumer spending, although the figures for car sales and cinema takings, for example, have recently improved. The experts at Union Investment forecast a weak fourth quarter of 2021 and first quarter of 2022, followed by stabilisation in the second quarter as credit data picks up. In the second half of the year, we anticipate stronger GDP growth around the ‘new normal’ mark of approximately 5 per cent per annum. We expect an inflation rate of 1.7 per cent for 2022. Inflation should ease over the course of next year, giving the central bank – the People’s Bank of China – the flexibility to bring in growth-supporting measures.
Construction sector still in trouble
Residential property sales (year-on-year change)
In addition to the coronavirus pandemic, there continue to be risks in the property sector, which is still a very important part of the Chinese economy. This sector will remain under considerable pressure for the time being. The government measures aimed at capping debt have made an impact, resulting in a significant slowdown in construction activity and residential property sales. There is now discernible stabilisation at a much lower level. Measures and announcements from the government are also starting to suggest that it is pursuing a more balanced strategy in the property sector again by focusing not only on reducing financial risk but also on stabilising growth. From a market maturity perspective, it is a good sign if China is permitting greater differentiation in terms of credit quality and companies can be wound up in an orderly fashion.
Three-way split among property developers
What does this mean for Chinese investments? Evergrande, the stricken and highly indebted property giant, is not out of the woods yet, so its bond prices are not expected to stabilise. A multi-year restructuring and winding-up process is only just getting started. Overall, Union Investment’s experts currently see a three-way split in the Chinese property developer market: companies like Evergrande that will not be rescued by the state, companies with poor credit quality, in respect of which the market is still regrouping, and property developers with an investment-grade credit rating that have achieved stability in recent weeks.
On the whole, however, our experts expect contagion from the Evergrande crisis to be limited and to remain mainly within the Chinese market. After all, there are few financial interdependencies between the Chinese property sector and the rest of the global financial system. These risks have now been priced in by the corporate bond market, so the prospects for 2022 look a little brighter. In the long term, the Chinese property sector is set to become more interesting again thanks to the reduction in debt and greater differentiation in terms of credit quality.
Slump in the equity market
Indexed performance since 31 Dec 2020
Niche topics offer plenty of opportunities in the equity market
Share prices have come under pressure in 2021, especially in the tech sector. In the past, increasing support from fiscal and monetary policy would always bring about a repricing. Next year, however, this impetus will be weaker than before, so it remains to be seen whether the pattern will be repeated. The sluggish pace of economic growth means that companies’ profits are likely to initially remain at a low level in the first half of 2022. It is still important to consider possible regulatory influences when it comes to security selection. At sectoral level, the tech sector remains subject to a high level of risk, whereas companies with better regulatory prospects are those involved in renewable energies, electric vehicles and battery manufacturing.
As at: 20 December 2021