Traditional data becomes less representative of the real Chinese economy
Investors: pay more attention to policy changes than predicting headline GDP or other mainstream data; focus on new growth engines, such as artificial intelligence and information technology
In the last update of our review of 2017, we highlighted one conviction that the dramatic turnaround of markets and investor sentiment in China during the year was driven by a series of policy surprises from Beijing.
The key question is whether these policy-induced market actions and economic rebalancing will continue in 2018. Our answer is yes, predicated on two assumptions:
● First, the Chinese leadership understands the flaws in the current economic model and is determined to shift its growth focus from quantity to quality.
The 19th Communist Party Congress has empowered President Xi to make tougher decisions. With a clear mandate to reform and enhanced ability to drive policy designs, we think stars are aligned for Xi to press ahead with more difficult reforms in the coming years.
● Second, the cyclical economic backdrop should remain conducive for reforms in 2018.
A key reason why Beijing has moved so boldly on reforms this year is because of the cyclical revival in the Chinese economy. This positive macro backdrop has created, what Central Bank Governor Zhou Xiaochuan has referred to as, a “critical window of opportunity” for the government to undertake reforms.
We think this window will remain open in 2018, helped by steady external demand and resilience in China’s New Economies (loosely defined as sectors relating to consumption and services).
With that in mind, what policies should investors pay attention to in the year ahead?
The recent meetings by China’s top policymakers, including the Central Economic Work Conference, have sent important signals. We have the following three takeaways:
1. There is a subtle shift of policy priorities from industrial de-capacity and housing destocking to financial deleveraging and environmental protection. The former two appear to have moved down the rank of importance, as healthy progress has been made to restore supply-and-demand balances in both sectors.
Replacing them on the policy top spots are financial deleveraging and environmental clean-up. On both fronts, the official rhetoric and policy actions have been surprisingly forceful this year, and there has been no indication that the authorities are backing away.
The recently announced new regulation for the asset management industry, for example, will help to institutionalise tighter controls on shadow banking, helping to keep interest rates at elevated levels and drive bond market volatilities in 2018.
Likewise for environmental protection, we see a strong determination to continue the campaign, as building a sustainable and green economy has become a strategic priority for the Party.
But besides closing down heavy-polluting and illegal factories, more policy support for clean and renewable energy are likely in 2018. This will help to make the operation more neutral for growth, and supports the rebalancing in the economy.
2. Beijing may be pursuing a shift from quantity to quality of growth, but it will not do so by compromising macro stability. While both – growth transition and risk prevention – are critical for ensuring a smooth economic transformation, if and when the two are in conflict, the latter will always take priority.
For investors, this means that financial markets are likely to operate within Beijing’s tolerable ranges. Policy-induced shocks – such as aggressive rate rises due to deleveraging and sharply cooling housing market due to policy tightening – will be duly countered, if they are seen as posing a threat to economic stability.
Protecting the policy redline of avoiding systemic risks will be the priority of priorities for Beijing. Hence, even though we are expecting an acceleration of reforms in 2018, a necessary condition is that China does not experience any major setbacks in the economy and markets, so to ensure that the “reform window” remains open.
3. Beijing’s pursuit of economic rebalancing may gradually morph into a more balanced “carrot and stick” approach.
As the New China commands a bigger share of the economy, growth rebalancing will not have to involve hammering the old industries alone, but nurturing the new economy may deliver even better results.
This is why the authorities have started to focus on strategies of fostering new growth engines such as in artificial intelligence and information technology, for instance, investing in research and development, and building a better social safety to unlock growth in Chinese consumers.
Even short-term policies may see a recalibration as the beta of the economy shifts. Targeted RRR cuts for small-and-medium-sized enterprises (as opposed to large state-owned firms) and tax reliefs for consumers (as opposed to companies) could be more effective in providing counter-cyclical stimulus without compromising the long-run agenda of economic rebalancing.
Overall, we expect the policy-induced market actions and economic rebalancing to continue in 2018. For investors, paying attention to these policy changes will be more rewarding than predicting headline GDP or following traditional data, which has become less representative of the real economy.
Hence, enjoy your holiday and make sure that you have your policy-reading glasses on for 2018!
Sources: AXA IM as at December 2017
Aidan Yao is senior emerging Asia economist at AXA Investment Managers