By Piyush Gupta
Piyush Gupta, CEO of DBS, shares that he does not believe that China’s macro economy is the point of concern. Instead, he argues that China’s risks are concentrated in two key areas. If one is smart, understands the long game and chooses opportunities wisely, China is still a good place to be invested in.
To many, the start of 2016 likely portends an annus horribilis. The carnage in China’s stock markets last week, sparked by downbeat manufacturing data, rattled stocks from US to Europe. The depreciating yuan is also unnerving investors.
Are the Chinese authorities losing their grip on the China economy, and is the world’s second-largest economy coming off the rails? Notwithstanding the market rout in China, and the present market volatility besetting markets, sitting where I am in Asia, I do not believe China is falling off a cliff.
Last Monday, everyone got spooked by China’s PMI (Purchasing Managers’ Index) data, which stayed under 50, signifying contraction, for the fifth month in a row. However, given what China is seeking to accomplish, PMI is completely the wrong metric to look at, for one important reason: the contraction in industry and manufacturing is being engineered by the Chinese. This is part of a calibrated policy outcome. For five years, the world told the Chinese they were overinvested, and needed to scale back on overcapacity and manufacturing. There was a clamour for China to shift to a consumption economy. And for the last two years, the Chinese have been focused on trying to do just that. So it should come as no surprise that China’s PMI should come in at below 50, and why I think focusing on this metric is not sensible.
The reality is that a) China’s service sector is growing quite nicely (PMI at over 54 in the same period) and b) the slowdown in manufacturing/investment reflects a need to clean up excess capacity in several sectors, notably construction, steel etc., but this does not mean that China’s heydays as an investment destination are over. China’s big problem has been a misallocation of resources, and they will need more than a couple of years to address the problems that arise from this. Nevertheless, it is instructive to note that overall, China’s actual investment (capital-output ratio, capital-labour ratio) is a fraction of the US. There are large parts of China, including healthcare, services and the environmental sectors, which are massively underinvested. What this means is there is scope and capacity for China to pump-prime the economy, and it has done so with some measure of success: while the PMI data is below 50, this has been inching up in the last couple of months.
A lot of people accuse me sometimes of being a China bull and overly sanguine about the risk in China. However, I want to differentiate my view of the macroeconomy from my view of China risks. The two are not the same thing. China risks are real, but they are concentrated in two areas:
a) Financial market volatility due to China’s attempt to open up, but still fine-tune through policy actions. China’s authorities are focused on financial sector liberalisation, and the pace at which this has taken place has been faster than expected. For example, the Stock Connect was introduced, quotas on QFII were relaxed, and ceilings on deposit rates removed, all in the last 15 months. The free flow of markets has impacted many of China’s asset classes. It is a truism that when you start to drive financial sector market liberalisation reform, there will be financial market volatility.
This is compounded by the fact that while China is attempting to open up, it is also seeking to fine-tune market responses through policy actions. And these policy decisions are taken by a myriad of people, regulators and government agencies. A lot of people think China is one person: that Xi Jinping makes all the decisions. That would be simplistic in a nation of 1.3 billion people. In reality, the central authority in Beijing, the PBOC, CSRC, CBRC etc, have different agendas. Different people march to different tunes. While policies are broadly orchestrated, not everything is carefully calibrated each time. One may therefore find oneself on the wrong side of policy responses.
b) Credit risk/corporate defaults. Anti corruption, SOE reform and depreciating yuan will put pressure on many companies. China is cracking down on corruption, and this drive could create risks for companies related to affected individuals, creating idiosyncratic counterparty risks. China is also pursuing SOE reform, which means less competitive companies will be weaned out.
To top this off, I believe the depreciation of the yuan will likely result in a good number of corporate defaults. In fact, I dare say that the currency depreciation is perhaps the single biggest risk to focus on this year.
While the yuan has been falling, China will continue to let its currency depreciate because exports are proving to be a drag. China does have a massive export trade surplus of $160 billion a quarter, however, that is coming down. It will therefore have a bias to let its currency depreciate relative to the dollar, even if this is held steady relative to the basket. This is a risk to watch because there has been a lot of Chinese corporate borrowing, much of which dollar-denominated, in the last year or two. A lot of this is unhedged. As the yuan depreciates, it is likely that a significant number of Chinese corporates will find their capacity to service debts will be challenged; this would be reminiscent of what Southeast Asia saw in 1998.
All in, China has risks, and they are clearly real risks. However, I do not believe that China’s macro economy is the point of concern. China’s economy is growing at 6-7%, and will continue to grow at this pace. What is more worrying is that the year will be marked by significant market volatility, more corporate defaults and higher counterparty risk. Nevertheless, if one is smart, understands the long game and chooses opportunities wisely, I believe China is still a good place to be invested in.
The article was first published at Linkedin Pulse and is reprinted with permission from the author.
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About the Author
Piyush Gupta is Chief Executive Officer of DBS Group Holdings, a leading financial services group in Asia, with assets of approximately USD 350 billion, and with over 280 branches across 18 markets. DBS was named “Bank of the Year, Asia” in 2012 by The Banker, “Best Bank, Asia-Pacific” in 2014 by Global Finance, and “Safest Bank in Asia” from 2009 to 2015 also by Global Finance. Prior to joining DBS, Piyush was Citigroup’s Chief Executive Officer for South East Asia, Australia and New Zealand.
