Yes, investing in China carries risks...but the bigger risk is NOT investing there
Investors should always take account of predictable risks, or grey rhinos, when making decisions. And China is no exception. But right now investors should arguably be less worried about being gored by a grey rhino than of not having exposure to the Chinese economy.
Economists such as Harvard University’s Ken Rogoff continue to point out the risk of a hard economic landing in China. Geopolitical risks such as the potential impact on China of a further upsurge in tension in the Korean peninsula or a worsening of China-India relations, even if they are not strictly speaking grey rhinos, cannot be dismissed.
Nor should investors rule out the possibility of deterioration in China-US trade relations.
But investors should anyway always quantify risk when evaluating strategies. And as regards China, at this point in time, the potential upside probably outweighs the risk.
US bank Goldman Sachs, writing last Thursday, expressed an optimistic macro-view of China.
Goldman expects “macro stability to be maintained in the coming months in the run-up to this autumn’s 19th Party Congress” and believes the stable growth platform will allow China’s policymakers “to maintain the focus on financial sector reforms.”
“Headline news on China credit problems have been relatively quiet over the past few months, reflecting the robust activity growth so far this year, with real GDP growth at 6.9 per cent [year-on-year] through Q2,” it wrote, noting too that “there has been little sign of a pickup in corporate distress.”
Last week’s dovish interest rate hold by the Bank of England set another US bank, Morgan Stanley, thinking about the British pound and if it might become a funding currency. But if sterling is a sell, what currency is the buy?
Morgan Stanley concluded that the offshore yuan could offer value versus sterling, taking a positive view on China.
The offshore yuan “should do well as [China’s] authorities rebalance the economy from net exports and investment to consumption and tech,” Morgan Stanley wrote. “China’s equity market has understood the message, seeing its consumer sector outperforming as the higher [yuan] suggests better real disposable income.”
But sell-side analyses aren’t the only reasons why investors might currently be drawn to China.
A report last month from the Bank for International Settlements (BIS) noted how international banking activity rose in the first three months of this year and that “cross-border lending to Emerging Market Economies picked up strongly, rising by US$151 billion in the first quarter of 2017 and growing by 8 per cent on a year-on-year basis.”
Breaking down that US$151 billion, the BIS wrote that the increase “was driven by a small number of borrowing countries, most notably China.” “Claims on [China] rose by US$92 billion between end-2016 and end-March 2017,” it wrote, “marking the largest quarterly expansion in the last three years and partly reversing the previous several quarters of contraction.”
Of course, some might argue that such capital is pouring into investments that won’t pay out. That includes infrastructure projects.
As the Manila-based Asian Development Bank (ADB) wrote in late July, China is “a heavyweight when it comes to infrastructure investment,” estimating “that on average from 2010 to 2014, [China] invested 6.8 per cent of GDP in infrastructure – defined here as transport, energy, telecommunications, and water and sanitation infrastructure.”
“Most other countries in developing Asia have infrastructure investment rates below 3 per cent of GDP – less than half [China’s],” the ADB noted, “and this despite the infrastructure in many of these countries being in much poorer shape.”
But, the ADB argues, this isn’t a case of China over-investing in infrastructure as “the country’s infrastructure investment needs are and will continue to be large.”
Indeed “given [China’s] projected growth rate (which is assumed to decline in the coming years) as well as projected changes in population, urbanization, and economic structure, [the] ADB estimates that [China] will need to invest US$753 billion a year in 2016–2020.”
And these aren’t vanity projects.
The ADB wrote that “an even starker picture of [China’s] future infrastructure needs emerges when it is compared with developed countries.” “More than two-fifths of [China’s] roads remain unpaved, compared to just 2 per cent of roads in the US and Europe.”
Investors might legitimately ask themselves where else on earth outside of China is going to offer the same kinds of investment opportunities on the same scale.
Capital has to be in to win, grey rhinos or no grey rhinos. Fear of missing out will likely trump any fear of being gored.