In large swathes of the world, consumers are enduring high prices, and high interest rates. In its fight against inflation, the U.S. Federal Reserve has pushed interest rates to their highest levels in 22 years. In the past couple of months, The Bank of Canada, the European Central Bank, and the Bank of England have all raised rates. And there is little consensus on what decisions central banks will make in September.
However, one central bank cut interest rates in August – the People’s Bank of China lowered its one-year loan prime rate to 3.45%. China doesn’t have an overheated economy and thus is chartering its own macroeconomic policy path. However this is not to say the picture is rosy. Policymakers in Beijing are confronted with their own set of challenges, including deflationary pressures, yuan depreciation as well as a shrinking property sector.
Economists and market observers suggest that these challenges could potentially have broader implications beyond China's borders, such as:
- The impact on global metal exporters,
- New trade partnerships, and
- Cheaper goods for developing markets.
Does this mean that now’s the time to bet on China? Or does it make sense to bet against the world’s manufacturing hub? We address each of these in some detail.
What Ore You Talking About? Global Metal Exporters Are Hurting Because of the China Property Downturn
The downturn of the property sector, which used to be a primary economic growth driver, is an example of the impact of China’s campaign to deleverage its economy and reduce its reliance on debt- and investment-led growth. This downturn has had wider reaching effects, as amidst weak Chinese domestic investment and sluggish sales of new homes, commodity-exporting countries that are exposed to China as an end market have taken an immediate hit.
Economists think this environment will continue to depress global commodity demand and the price of commodities.
Robert Gilhooly, senior emerging markets economist at abrdn, says: “Commodity exporters, such as Chile, Peru, South Africa, and Australia, could see less demand from China. This in turn will lead to cooling global prices, with knock-on effects impacting investment, tax revenues, and broader business sentiment.”
Over the longer-term, the deleveraging exercise that is currently underway is an attempt to transition the economy to one that is more consumption-led, as opposed to an investment-led one. Gilhooly explains: “Since investment is relatively import-intensive, China’s shift to endemic living is likely to provide a relatively muted boost to its trading partners.”
In Gilhooly’s view, among major emerging markets, Chile and Peru are particularly dependent on metal and ore exports, and as such they could be more exposed to a further drop in property-related import demand from China.
Let’s Make a Deal: The Slowdown in China Could Lead to New Trade Partnerships
Equally, investors should not forget that the trading pattern isn’t static, and subdued demand from China can be offset by other economies and sectors that are in need of raw material and commodity inputs.
Chris Kushlis, chief of China and emerging markets macro strategy at T Rowe Price, agrees that producers of metals solely tied to housing construction could face pressure from China’s slowing property development. However, a shift towards green energy infrastructure may provide support to metals-intensive exporters in South America, Indonesia, and South Africa.
On the other hand, Kushlis believes China’s offshoring of lower value-added production to frontier markets in Asia has the potential to bolster consumer goods exports from those regions and argues that these changing trade patterns have differential effects across Asia and emerging markets.
Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management, monitors the import intensity dynamic between China and its trading partners. He says: “The outlook for Asian exporters increasingly hinges on the global outlook and not just China. This is because China’s import intensity – how much it imports per unit of GDP growth – has been slipping for a while now. Falling import intensity has been led by the secular easing of processing trade, the Sino-U.S. trade conflict, and the downturn in China’s property sector.”
The Price is Right: Developing Markets Love Cheaper Chinese Goods
Exports to China could be under pressure, but cheaper products are a boon to importers of Chinese manufactures. This holds especially true for economies struck by stubbornly high inflation, which welcome lower prices from the world’s manufacturing hub.
Tiffany Wilding, economist and managing director at PIMCO, says: “While disruptions and changes to post-pandemic economies have raised questions about the extent to which the Chinese economy still dominates global trade and industrial cycles, we see several reasons to expect spillovers to intensify in developed markets.”
She believes deteriorating Chinese economic fundamentals have produced deflationary pressures that are already moderating inflation both in China and in the global markets served by Chinese goods.
In Wilding’s view, persistent deflation in China would likely spill over to developed markets. “A weaker yuan and elevated inventory-to-sales ratios lower the cost of Chinese goods abroad – a development central bankers in developed markets would likely welcome.”
According to the National Bureau of Statistics of China, the producer price index (PPI) – which tracks the prices that factories charge wholesalers for products – fell by 4.4% year on year in July and was down for a tenth consecutive month.
While a declining PPI that is typical of deflationary periods tends to signal an upcoming economic slowdown, Wilding thinks the spillover of falling prices of Chinese products is deemed near-term good news for the Western central banks’ fight against elevated inflation.
She explains: “Despite changing linkages between China and the global economy as Beijing tries to transition to a consumption-led growth model and trade tensions remain elevated with the West, China is still the world’s manufacturer.”
Over the short-term, Wilding is observing the usual lags in economic prints and says: “Deflationary spillovers have likely only just begun to impact global consumer markets, with discounting likely to accelerate over the coming quarters.
Show Me the Money: Economists Are Awaiting Stimulus from China
As the backdrop remains deflationary for China, economists say the next catalyst that they think is pertinent to kickstarting the economy is policy stimulus. BNY Mellon IM’s Mitra is among the market watchers who worry that China could see a worse year ahead if the right amount of policy support isn’t in place.
“[The property sector] is indeed the biggest driver of the downturn in the Chinese economy. It accounts for around one-quarter of Chinese GDP and its slump has clearly hurt growth. But the erosion of private sector confidence has, likely, limited the scope for any offsetting upturn and fueled the deflationary spiral.”
At the time being, Mitra says he’s awaiting “a larger stimulus, which has been hinted at, but has not materialized thus far.” As he calls for a supportive policy package, he says: “A prolonged delay in policy support and market reform will likely endanger the outlook for China in 2024 and beyond.”
Whether the risk of more pronounced deflationary pressure could deepen, PIMCO’s Wilding adds that adequate fiscal stimulus to boost domestic demand may reaccelerate inflation, while delayed or inadequate policy measures could lead to a downward spiral.
T Rowe’s Kushlis, who looks at the impact on currency and fixed income, believes more stimulus, including additional interest rate cuts and increased fiscal spending, is needed.
Otherwise, the Renminbi will continue to face depreciation pressures from the global U.S. dollar strength, given high front-end U.S. yields relative to lower yields in China. This is despite the authorities’ efforts to manage the pace of this pressure through a range of active measures in the currency market, he says.
Deal: The Question is Whether it Makes Sense to Bet on a Policy-Driven Rally…
Matt Wacher, chief investment officer for Asia Pacific at Morningstar Investment Management, says investments take more than economic indicators.
“There's a downturn and there's no denying that. Being an effectively state-controlled economy where the government has a number of leads that they can pull, I don't think it will go into a Japan-type scenario, even despite the demographic headwinds.”
Wacher continues: “We tend to look through the cycles, so we don't think that this situation in China is going to last forever. We think that if you look through the cycle some of the valuations particularly in China itself are quite compelling at this point in time.
He continues: “Countries like the U.S., I think that they're going to be less affected by what goes on in China these days as the U.S. has a much larger economy than both Australia and Brazil for that matter, a much more diversified economy… So just because it's not going to be affected as much by a Chinese downturn doesn't mean that it's an opportunity like we don't think you should go and invest heavily in the U.S. But, because we think that there's valuation risk there, especially in parts of the market that have rallied very hard this year.
In terms of valuation, Wacher says: “Now is a good time to invest in China and that’s certainly what we've been doing. We don't have huge positions, but we have reasonably good exposure.”
…Or No Deal: Should You Bet Against China?
The aftermath of the anticipated support remains to be monitored, says Gary Ng, senior economist for Asia-Pacific thematic research at Natixis CIB.
Ng says investors, especially those betting on a policy-driven stock rally, should keep expectations in check with the accommodative policies, despite signs of the government’s willingness to stabilize growth.
Ng says: “The market should not be over-optimistic about the size. It means it is unlikely to see any significant boost to corporate profits and household income. There are more sectors with green shoots, such as electric vehicles, green energy, and tech, but they are not big enough to offset the drag from real estate.”
BNY Mellon IM’s Mitra told Morningstar that the firm has taken a neutral position on Chinese equities before further policy stimulus from the Chinese authorities is announced and launched. The risk could be capped as the market widely expected such a downturn. “In this backdrop, it is difficult to foresee how things much worse unless the growth outlook materially deteriorates from here – say to below 4% year on year, which is not our base case. In a similar vein, the price of commodities likely already reflects the weakened state of Chinese fixed asset investment.”
He continues: “We suggest staying neutral on Chinese equities which remain too cheap to short and too weak to go long and are likely to provide a hedge against elevated and rising rates in the G3 markets (the U.S., eurozone, and Japan), and recession risks in several pockets of the developed world.
Don’t Forget Fixed Income
Turning to fixed income, T Rowe’s Kushlis believes despite the economic hardship, China is avoiding a "balance sheet recession" as end borrowers are not facing debt servicing constraints. Interest rate cuts are keeping mortgage and local government debt sustainable.
He likes Chinese local currency government bonds. He thinks these assets as attractive given falling yields. He expects yields to remain low or fall further as the People’s Bank of China continues cutting rates to support the economy. The policy response is expected to be more supportive through incremental measures.
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