China Economy
Across The Border
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Investor sentiment toward Chinese economy highest in two years, analysts say

But concerns remain over the expansion of the state sector, capital controls and the sustainability of investment-led growth

PUBLISHED : Monday, 31 July, 2017, 3:13pm
UPDATED : Monday, 31 July, 2017, 10:35pm

Overseas investors are more sanguine about China’s economy and stock market than they have been for two years, their confidence bolstered by recent economic data that has beaten forecasts, analysts say.

But long-term concerns linger, among them tighter capital controls, doubts over the sustainability of China’s investment-driven growth model and what many see as the advance of the state sector at the expense of private firms.

“The sentiment is at its highest since mid-2015,” said Larry Hu, an analyst with Macquarie Capital, after he met with investors in Europe and Asia.

“Investors cited global central banks’ accommodative policy and strong earnings growth as the reasons to buy pullbacks.”

A research report released by Goldman Sachs last week seemed to echo Hu’s anecdotal findings. The investment bank’s Chinese market-implied growth indicator had continued to improve in recent weeks, implying better market sentiment, the report said.

The consensus is that policymakers will do whatever they can to maintain stability in the run-up to the [Party] congress
Larry Hu, analyst, Macquarie Capital

The heightened sense of optimism came after China’s overall economic strength accelerated strongly in June, with all subsectors – employment, trade, consumption, construction, services and manufacturing – enjoying stronger momentum.

“Our MAP (Macro-data Assessment Platform) index of [Chinese] economic growth surprises picked up to 0.7 in July from 0.4 in June,” said Maggie Wei, an analyst at Goldman Sachs.

Positive data surprises from second-quarter gross domestic product, June activity and trade data contributed to the increase.

The International Monetary Fund recently raised its China 2017 growth forecast again, this time to 6.7 per cent growth, up 0.1 percentage point from the April prediction. It also raised its forecast for 2018 growth to 6.4 per cent, up 0.2 percentage point from the April estimate.

The revisions came shortly after China reported second-quarter growth data that exceeded expectations. GDP expanded 6.9 per cent, topping a consensus estimate of 6.8 per cent and matching the growth in the January to March period.

Among the growth engines were familiar favourites like accelerated government spending on infrastructure, construction investment and strong retail sales.

Still, as the growth picked up, investors became less concerned about risks such as debt, property, capital outflows and the renminbi, said Hu.

Instead they focused on the upside risks in the second half, namely the liquidity outlook and the implications of the upcoming 19th Communist Party’s National Congress.

“For China specifically, investors don’t see much downside risk in the second half of 2017, given the coming Party Congress,” said Hu.

“The consensus is that policymakers will do whatever they can to maintain stability in the run-up to the congress.”

In the property market, housing demand has proved more resilient than expected. Strong home sales in the first half were largely the result of demand in lower-tier cities.

However, long-term concerns about a credit bubble and capital flight still exist.

“The current cyclical upturn is largely driven by the real estate sector and to a lesser extent, external demand,” Hu said. “Both are unsustainable, in our view.”

Mortgage rates are set to rise as the funding costs for banks have been pushed up by the government’s crackdown on financial leverage. More lower-tier cities have also tightened their restrictions on property purchases.

Equally important, home prices in tier-one cities started to drop in June and are likely to fall in the second half, which could dampen sentiment in the rest of the country, said Hu.

Another worry is the rising influence of the state sector in the Chinese economy, which could hinder market-oriented reform.

“Ownership reforms such as those for state-owned enterprises [SOE} or land reforms are difficult,” Hu said.

“In our view, SOE reform is largely about downsizing SOEs, while middle-ground measures such as mixed-ownership reform can only go so far.”

The Chinese government has stressed in the past five years that it will carry out mixed-ownership reform, aiming to liberalise the economy by allowing private investment in state enterprises. However, the implementation has been rather slow, with the regulators having only just approved a few selected enterprises for the reform.

Risks lurk in China’s macro outlook too. Policy messages suggest the financial regulatory storm is far from over, while the growth in property and infrastructure investment are set to slow in the coming years.

“China’s leaders need to find new drivers to fight the so-called ‘middle-income trap’ because economic growth is the legitimacy of the ruling Party and the key to its mandate of ‘making China great again’,” Hu said.

That said, there are still a number of investment opportunities in micro trends emerging in the Chinese economy. These include the rise of the services economy, digital transformation, consumption upgrades, urbanisation and the formation of city clusters, as well as the transformation of Chinese corporates on the back of industrial upgrading and globalisation.

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