Take another look at China

A common narrative about China is that while it was once a powerhouse of global growth, this is no longer the case and investors should look elsewhere for strong returns with less risk.

At a recent presentation to investors, David Perrett, Co-head: Asia Pacific Equities at M&G Investments (UK) and I explored this narrative and put forward reasons why China’s growth story is, in fact, still intact.

On the back of its trade and investment reforms, China experienced a surge in foreign direct investment (FDI) beginning in the early 1990s. These flows were a major source of China's productivity gains and rapid economic and trade growth, and for the first 15 years of the 21^st century China was highly valued by emerging market investors.

However, the country was fueling much of its growth through debt. It lent trillions of dollars to local governments, their financial affiliates and real estate investors, as well as nearly US$ 1 trillion to 150 developing nations. As a result, global investors became wary, with some excluding China from their portfolios altogether. Recently, researchers at JPMorgan Chase calculated that overall debt within China – including households, companies, and government – had reached 282% of the country’s annual economic output.

Another negative storyline has been China’s harsh lockdowns during Covid and its reluctance to lift these once the threat of the pandemic had lessened. But in fact, its lockdowns weren’t national; they were localised and targeted. There were even incidences where workers were locked into factories to maintain production, baleful as this tactic may be. Then, when China lifted its zero-Covid policy, investors thought there would be a massive economic boom that would flow through to the global economy. However, we’re already in the eighth month of the year and this hasn’t materialised. But it’s not just China’s fault: Western consumer demand has been weak coming out of the pandemic.

Looking at steel demand, which is considered a proxy for industrialisation and urbanisation, the country’s volumes declined during Covid and are not expected to resume their pace of expansion of previous years. This is because, although there is room for further growth, China has already reached a 60% urbanisation level, just shy of its goal of 65%. Still, it will   continue to be a significant part of the overall global market going forward as the world’s second-largest economy.

China’s future: the energy transition

Steel isn’t the only commodity that matters, as China consumes about 50% of all global commodities, which in addition to iron ore includes aluminium, copper, nickel, and zinc, all of which are required to manufacture the products that will be the backbone of the world’s green energy transition. And that is where China’s future lies.

The country is already far ahead of the rest of the world in gearing up for the burgeoning global demand for renewable energy, namely solar and wind power, as well as electric and new energy vehicles, both in terms of scale and price competitiveness.

It has more than 600,000 existing new energy vehicle enterprises and is the world’s largest market for new energy vehicles. These differ from electric vehicles in that they use new power systems driven by new energy sources including plug-in hybrid, pure electric, and fuel cell vehicles. Electric vehicles are those powered by electricity instead of liquid fuel.

Then there is battery production. China has over three-quarters of the world’s battery production capacity. Moreover, it houses more than half of the world’s processing and refining capacity for lithium, cobalt and graphite, which are essential materials for making electric vehicle batteries, which in turn are among the most important and expensive components of an electric vehicle. The country also boasts 70% of the global production capacity for cathodes and 85% for anodes.

Looking at other aspects of the Chinese economy, inflation is very low (in fact, there has been deflation recently), the yuan is trading at weak levels and interest rates are falling. These conditions make for a competitive economy as global trade starts to pick up. In late June, in a bid to help boost growth, the People’s Bank of China lowered the one-year loan prime rate by 10 basis points to 3.55% from 3.65%, while trimming the five-year rate by 10 basis points to 4.2% from 4.3%. This lowers borrowing costs for both companies and households, and additional fiscal stimulus measures are expected from the government.

In conclusion we believe that, while China is still working its way through the headwinds it has faced over the last few years under Covid and its aftermath, between the energy transition, a weak currency, relatively low inflation, lower interest rates and further policy stimulus, the macroeconomic conditions aren’t so negative. It’s time for investors to take another look at this Asian giant.