Why China shouldn’t let a good trade war go to waste
“Never waste a good crisis.” The term has been variously attributed to Renaissance Italian diplomat Niccolo Machiavelli, British Prime Minister Winston Churchill and former US President Barack Obama’s chief of staff Rahm Emanuel.
It’s surely one that Chinese President Xi Jinping and his coterie of Communist Party officials must be considering as the country’s trade war with the US lurches onwards.
From a macroeconomic perspective it has been a painful experience for China. It has seen most of its exports to the US become more expensive, courtesy of the raft of tariffs that US President Donald Trump has imposed, hurting a variety of industries. It’s forced Beijing to look at stimulus measures, including asking local institutional investors to support a set of infrastructure debt issues.
Meanwhile the renminbi’s valuation has pierced the once (tacitly) sacrosanct level of Rmb7 to the US dollar. The difficulties the country is experiencing has led a set of economists to cut their GDP growth predictions for the year to under 6%, the first time China’s economy would have grown at such a slow rate in 29 years.
The temptation in all this economic difficulty might be to hunker down, refuse to make changes, and hope things improve. But China might be better served by using these difficulties to push through the financial reforms it will need at some point to ensure its long-term prosperity. And it can appeal to institutional investors to help it.
First of all, the weakening of the renminbi means the country no longer faces such a dire need to control the outflow of capital. Previously Beijing heavily circumscribed official outflows, in order to prevent the subsequent conversion to other currencies from weakening the value of the currency.
Taking a looser attitude towards the value of the renminbi could mean that it can let its asset owners invest more of their assets offshore, at least on a controlled basis, after more than 18 months of stricter capital controls. Plus, having more assets offshore would allow asset owners to benefit from further weakening of the renminbi.
Allowing this would be good for the nation’s insurers and pension funds because they could better diversify their allocations, both geographically and into a broader array of assets too, thereby reducing their exposure to the vagaries of Chinese financial markets. Insurers are permitted to invest up to 15% of their assets offshore, with government approval, but none are anywhere near this ceiling today.
Beijing could also loosen some of the investment limitations on the provincial fund investments that are overseen and invested by the National Social Security Fund. For example it could allow the NSSF to invest more of these funds in offshore and long-term private assets like infrastructure and private equity, which would suit the long-term investment needs of the fund.
Potentially these funds could be co-invested with multilateral institutions like the Asia Infrastructure Investment Bank to encourage and support offshore infrastructure development, in keeping with China's Belt and Road Initiative.
As a sign of its growing inclusiveness and willingness to encourage inbound investment, Beijing could also aim to speed up the opening of its capital markets to international investors.
To its credit, the country has already expressed a desire to do this. In June, Yi Gang, governor of the People’s Bank of China, said the central bank would support efforts to fully remove foreign-ownership limitations in domestic fund management companies (FMCs) by 2020. It also accelerated the date by which wholly foreign-owned enterprises involved in investment management can apply to be local FMCs to next year from 2021 – a move that will enable them issue their own mutual funds.
But it could go further.
The plans announced to date would only allow FMCs to issue funds underpinned by local assets. And given their collective experience as international fund managers it would make sense to let them also issue mutual funds that include or even target offshore assets.
That would help to diversify the sort of investments that local investors can participate in and allow their investment fates to be less tied to volatile local markets.
On the flip side, Beijing could use the current challenges to accelerate plans to modernise its capital markets. One important step would be for the government to allow high-profile bankruptcies to take place where companies are highly indebted. Forcing some bankrupt firms to restructure their debts or enter insolvency would create some valuable precedents for debt restructuring – a valuable development as the economy slows.
From an investment perspective it would (ultimately) be a good thing too by removing so-called moral hazard. It would help ram home the idea that the government won’t stand behind every borrower and underline to local and international investors that there is such a thing as genuine credit risk in China.
That, in turn, would force investors to better assess the risks and rewards of the bonds of different companies.
In tandem with this, Beijing could accelerate its approval of onshore licences for international rating companies. Doing so would encourage international standards of debt analysis and help to differentiate this credit risk, which in time would also help persuade more international bond investors to put money into a broader array of Chinese renminbi bonds.
After all, with more renminbi debt being included in global bond benchmark indices that is something they will increasingly want to do in the coming years. So why put up obstacles?
None of these steps will prevent China from suffering tougher economic times, as the trade war continues to mount.
But they would underscore the government’s desire to encourage more financial products and greater investment transparency. And that is set to become increasingly important as the country’s increasingly international companies begin to rely more on inbound capital.
Investors interested in the strategies of China’s asset owners can learn more at AsianInvestor's sixth Institutional Investment Forum China on September 18 in Beijing. Please click here for more details.