Asia insights

Step-up in China policy easing

This month’s cut in China bank reserve requirements is just one of an array of measures Beijing is taking, mostly not headline grabbing, to support the economy going into a politically important 2022 with the Communist Party Congress. China’s growth is slowing down and we think Q4 year-on-year GDP could come in below 4%. This is worrying policymakers. The annual target for 2022 is not yet announced but is extremely unlikely to be below 5% - achieving the long-term growth target of doubling GDP by 2035 (from the 2020 level) requires average annual growth of at least 4.7% and most people, including policymakers, believe potential growth is on a downward trend, not least because of unfavorable demographics.

Further growth challenges also lie ahead, including The Winter Olympics in February and the Paralympics in March. This will entail broad shutdowns and restrictions on industrial plants, constructions sites and heavy truck transportation around Beijing to ensure good air quality. The desire to keep a zero-tolerance Covid-19 policy – especially with the new Omicron strain and a rising number of foreign visitors for the Olympics – may lead to more stringent restrictions on traveling and gathering at a time when these activities typically make a larger contribution to the economy during the Lunar New Year.

That said, policy loosening has been below expectations and behind the curve relative to the softening economy. Yet the pace has picked up as the slowdown became more apparent with Q3 GDP data. Recent policy statements have clearly turned more dovish, reinforcing that more action is coming. Without some further loosening, we believe the country’s long-term growth goals will be hard, if not impossible, to achieve. And the ability to deliver long-term economic improvements is a key pillar of government legitimacy that is unlikely to be abandoned. 

Which tools will they use? We think policymakers cannot be too picky: if they don’t want to use certain tools such as interest rates (to avoid attracting attention to the fact that policy easing is happening), other tools will need to be used more aggressively. We expect higher monetary targets for 2022 as well as a higher fiscal deficit. The official fiscal deficit target may not change much, but because the actual fiscal deficit in 2021 is still running far behind schedule and likely to undershoot this year’s target, more money is available for spending next year.

Stronger investment case

This expected further loosening of cyclical policy strengthens the China investment case, in our view. But it is not the only positive development.

In November, President Xi Jinping announced that China would open telecom and medical services to foreign companies.[1] Until now, the telecom industry has been completely dominated by state-owned enterprises (SOEs). Another key development: we have not seen foreign investors treated at a disadvantage compared with onshore investors with the defaults of property developers on their U.S. dollar bonds. Two months ago, it wasn’t clear if this would be the case. The government is also clearly turning more supportive of the property industry.[2] Default risks of other major developers will likely ease at the margin since policy tightening is the reason why so many of them are under stress.

Regulatory tightening has been much less aggressive compared with the clampdown that we saw in Q3. It is widely expected that the granting of gaming licenses will likely resume before the end of the year after a suspension of several months. The reason is simple: further aggressive regulatory clampdowns will weaken an already weak economy – and policymakers can no longer afford this.

Risks remain

The changes mentioned above are generally positive at the margin, but we still see important risks.

First, the overall default risk of weak property developers remains very high. Second, the conservative bias of policymakers could mean policy continues to stay behind the curve despite incrementally more support. Third, the change in tone in the December Politburo meeting statement was subtle except for on the real estate sector, though policy tone and implementation are often not very consistent. Fourth, while we likely have seen the peak of the regulatory campaign, we have certainly not seen the end of it. In a jittery market with low visibility, even smaller, more targeted regulatory tightening can cause big negative market reactions. Lastly, ongoing tensions between China and the U.S. will continue to pose risks, especially for U.S.-listed Chinese companies.

Overall, we favor China tactically given the likely policy action and still-weak sentiment. While the absolute level of risk remains elevated, including in the regulatory sphere, we remain overweight Chinese equities and Asia fixed income on a tactical horizon and on a strategic basis relative to the low holdings we see among global institutional investors.

[1] Bloomberg, China’s Xi warns on protectionism, calls for unimpeded vaccine trade, November 4, 2021.

[2] Financial Times, China eases pressure on property sector but reform remains priority, November 22, 2021.