7th November 2012
By developed market standards, growth in China is still impressive at 7.4 per cent in the third quarter of this year, but this level is viewed as pretty poor by recent Chinese standards. Such levels are also likely to be a recipe for increased political tensions. The accepted wisdom is that the Chinese people will mostly accept the Chinese Communist Party’s rule as long as it delivers acceptable levels of growth and prosperity.
That may actually be overly simplistic. China may not have democracy, but there is a huge amount of debate, dissent and several hundred riots a year, though they usually have local causes. The report from this week's Guardian shows how debate is tolerated across the regions albeit within limits. Most Chinese have concerns about corruption and party officials at every level who have enriched themselves.
Certainly, were the economy to continue at a relatively low level of growth then it could very easily provoke a political crisis. Therefore the politics and economics are arguably even more intertwined in China that in the UK or the US. The direction China takes therefore has huge implications. China has helped cushion the world from some of the worst effects of the economic crisis. At the same time, its trade imbalance with the West and particular the US was one of the macro-economic factors behind the crisis in the first place.
Therefore there is a huge amount of interest in the new generation of leaders and some expect some bold strokes to safeguard economic growth. Fund manager Schroders head of global and international equities Virginie Maisonneuve says: “This leadership team could be the last of its kind. The new leader, Xi Jing Ping, is still in the vein of Deng Xiao Ping who led China towards a market economy in the eighties, but he could potentially be steering China towards a new leadership style. “So far, Xi Jing Ping has kept a relatively low profile in the international community. He has also been quiet about his vision for the economic direction of the country. The son of a communist veteran, he has degrees in chemical engineering and political science and has held various roles in Fujian and Zhejiang provinces. He was given the delicate role of Shanghai Party chief after the fall out of Chen Liangyu after the social security fund scandal. He is known for his stance against corruption, his pragmatism and his diplomacy, which will be very much needed in the upcoming leadership team.
“The departing leadership team has been under pressure from the global financial crisis and the limited scope for substantial measures to support the economy. The new team under Xi Jing Ping will therefore have greater room to take decisive action to boost growth, most likely after March 2013 when the team officially takes over the country from an economic standpoint.” Some commentators suggest that the next natural stage in China’s development requires a huge transition and reform programme.
One US academic argues that the Chinese currency the renminbi may become a global reserve currency. University of California Berkeley economist professor Barry Eichengreen says the Chinese currency may join the dollar and even the euro, if it survives the crisis, in creating a multi-polar reserve currency world. Currently only the dollar holds this status. In a recent white paper published with the DWS Global Financial Institute, a think-tank set up by DWS, Deutsche Bank’s retail asset management arm, he says the dollar simply will not be able to continue in its dominant role as US share of global trade falls, and emerging economies continue to grow rapidly. “The capacity of the US government to provide safe assets, backed ultimately by its power to tax, will eventually be overwhelmed by the scale of the world economy,” he said.
But what may be most interesting for investors is that as part of this process China must make itself more appealing internationally. The professor writes: “Inducing private investors and central banks to hold a significant fraction of their assets in renminbi will require not just financial development but other reforms including legal ones.”
These reforms include placing China’s banks on a commercial basis so they can no longer be relied by central government to lend to local government for infrastructure nor to property developers. He adds: “Along with building a more diverse clientele of investors as a way of encouraging more trading and developing a more liquid bond market, China will need to reform its banking system so that central banks and other foreign investors feels comfortable holding deposits there.”
Schroders Virginie Maisonneuve also foresees big changes. She says: “The priorities post-transition will likely be continued financial reforms, pricing reforms – in areas such as gas, oil and power – state-owned sector reforms with a potential transfer of assets from companies in difficulty, and fiscal and tax reforms. The need for more housing and “acceptable” property prices may bring welcome land supply reforms which would impact developers and construction companies as well as commodities.
Finally, a focus on urbanisation could continue to be a driver for growth for many years to come.” The fund manager suggests that investors can gain exposure to China in a number of ways and not just directly. She writes: “Investors should not focus only on Chinese- or Hong Kong-listed securities to tap into Chinese economic growth, but look for streams of earnings in global and local companies, wherever they are listed. Although growth has slowed, and probably for the best, it still compares favourably to the rest of the world. Some of the best ways to play the on-going changes in Chinese society and growth opportunities are in the insurance, consumer and selected commodities areas.”
However some fund managers are much more bearish. Newton global high income manager James Harries recently told financial website Citywire that he believed a ten year boom in China was coming to an end. He said: “We remain sceptical on companies, sectors and economies dependent on China because we think the 10-year boom is coming to an end. China has not had a down cycle for 10 years, and people have become used to dramatic growth numbers. It has had a very substantial boom, so at some point it will have some kind of bust and we think that is now unfolding. While it has had a small bounce we think the long-term trend is down, and at some point we think people will wonder why on earth they put any money there at all.”
It is certainly an interesting call for investors in terms of the asset allocation given that many have increased their exposure to China. But whatever happens the economic and political impact on the rest of the world, and thus your investments, will be huge.