China model seen challenged in “hostile” environment
Leading China experts and investors remain bullish about the country's long-term growth story – at least outwardly. But there are more caveats than ever before because they see the Asian giant facing huge challenges in an increasingly hostile environment.
For one, experts argue that the relationship between China and the US is set to deteriorate further, regardless of whether American president Donald Trump remains in power and continues his protectionist policies.
“US-China frictions are certain to get worse,” believes Martin Wolf, chief economics commentator at the Financial Times. “That will be bi-partisan – the Democrats are in different ways quite as protectionist and hostile to China as Mr Trump is.
“Considering the Democrats' concerns over human rights – which Trump doesn't care about at all – the relationship could even be worse with a Democratic president,” he said during his keynote speech at the FT Investment Summit in London on September 24.
Others speakers made similar points during a panel later at the same event.
“Even if a Democrat were to win the next US election, there is a widespread partisan support for this deep change in American attitudes towards China,” said Diana Choyleva, founder and chief economist at London-based Enodo Economics.
The timing is also hardly propitious for China, raising question marks over the direction and viability of its development model under President Xi Jinping.
He pointed to the challenges it faces managing high and growing levels of debt, the value of its currency as capital markets are opened up, and its ageing demographics in the wake of its one-child policy.
China is also “trying to steer clear of the middle-income trap” by moving up the valued-added chain as wages rise and its manufacturing base becomes less competitive, Magnus said.
“On top of that now [Beijing has] a a very, very hostile external environment, which they've not had to cope with in the past,” he added. “At least not since Deng Xiaoping [who ruled from 1978 to 1992].”
Hence, Magnus concluded, “we should be aware that the China we are investing in for the next 10 to 15 years is not the China we thought it might have been 10 or 15 years ago”.
DEVELOPMENT MODEL DOUBTS
China's concerns range from the Trump-led trade spat to the ongoing protests in Hong Kong to the growing concerns in various Western countries over the use of Chinese technology and Chinese acquisitions of local tech assets.
Against this backdrop, some are expressing doubts about the economic model that Xi has adopted.
“In my nearly 20 years of covering China, this is the most negative I've ever been about the ability of its development model to pull through,” Choyleva said.
Xi is in a strong political position, and is being strengthened by the way Trump is conducting negotiations, she added. However, he is “undermining the most successful aspects of China's development model over the past 40 years” with his deployment of a top-down control model rather than allowing true private enterprise to flourish.
He has “thrown out of the window almost all of Deng Xiaoping's ideas” about market reform, Choyleva argued.
Ultimately, over the past 40 years China has had the luxury of time and of operating in a very benign international environment, speakers agreed, but is now under pressure to open up more quickly at a time of rising external threats.
Mark Mansley, chief investment officer of Brunel Pension Partnership, a local authority retirement fund in the UK, also raised doubts in this regard. He argued on the same panel that the Chinese model remained "intact" in that "the [Communist] Party delivers economic prosperity in exchange for" the support it receives. "The question is now whether that [prosperity] is now going to be impossible to fulfil."
Nevertheless, the expectation is that both China and India will continue to grow about twice as fast as the rest of world despite slowing global GDP expansion, Wolf said. “As a result, the slow and steady shift in the world economy [away from Western economic dominance] will continue.”
Slightly slower growth is likely Beijing's aim and is more easily achievable now, suggested Miranda Carr, London-based head of China thematic research at Haitong Securities, also speaking on the panel.
Part of China's rebalancing plan is to move from constantly trying to hit 6% or 7% growth to generating consumption-led growth of 4% to 5%, she argued.
And the trade war is actually beneficial on this front, Carr said, in that it has created a common enemy – Trump – that Beijing can blame for any drop in growth. Consequently, the government is undertaking the move to structurally lower growth and can do so more easily.
INVESTMENT TO CONTINUE
Ultimately, investors will continue to invest in Chinese assets as it opens up its markets and global index providers increasingly move to include onshore securities in their benchmarks. Global asset owners are steadily growing their mainland Chinese exposure, whether through local stocks, onshore bonds or private markets.
A growing number of pension funds and insurers – in Canada, the US and Europe – are making dedicated A-share allocations, moving to allocate to onshore debt or private equity. Though admittedly some, particularly US institutions, are treading more carefully given the current highly charged political environment.
“We are being allocated into China by dint of the changes to the indices,” Mansley said. But he argued that this is an important enough area that investors should not simply do it passively through an index, but should make conscious decisions about.
That appears to reflect a widespread feeling among Western investors: one must be allocated to China in the long term, but how and when to increase exposure remains a tricky question.
AsianInvestor offered more insight into China's investment industry at our recent 6th Institutional Investment Forum China, which took place on September 18.