Catherine Yeung weighs up the evidence as to whether China is headed for an economic hard landing.
The Chinese may have jostled against the Americans in the Olympics medal tally, but in the economic arena the US continues to retain its status as the world’s largest economy.
This is a position that is unlikely to be challenged by the Chinese any time soon due to rising concerns about the sustainability of China’s economic growth model.
While Chinese gross domestic product (GDP) growth has slowed this year, fund managers at Fidelity maintain the view that an economic hard landing is unlikely to occur at this point.
There are two views when it comes to investing in China these days – you either love it, or loathe it.
The bears (who have undoubtedly gained popularity this year) argue that Chinese economic growth has fallen more than expected.
They also question the calculation methodology and reliability of official data.
This lack of transparency has resulted in some commentators using measures such as power generation as a proxy for real economic growth. (Using this assumption, power generation grew only 1.1 per cent in the second quarter, suggesting GDP data has been overestimated.)
Conversely, the bulls dispute that while power usage might be used to monitor real economic growth, a drop in power usage doesn’t equate to a proportionate fall in GDP growth; for instance, although usage has fallen, 70 per cent is from heavy industry, whose contribution to GDP is significantly lower than 70 per cent.
Additionally, the bulls believe policymakers will ensure GDP growth doesn't fall below the official target of 7.5 per cent (even if this means a degree of massaging is likely to occur) and that the Government has enough ammunition to prove the critics wrong.
Generally speaking, much of China’s current slowdown was to be expected, given the tight monetary and property policies implemented in 2010 and 2011.
Additionally, it’s not too surprising to see growth momentum soften, given the suspension of infrastructure investment projects (such as railway and nuclear power plant developments) and fiscal expenditure cuts announced during the second half of 2011.
None of this translates into a hard landing.
When it comes to the hard landing debate, investors should be mindful that different commentators have different definitions of what constitutes a hard landing.
For some, it would be China slipping below 7 per cent growth, while for others China would have to deliver sub-zero growth.
Broadly speaking, we define a hard landing as something that occurs when the three main engines of growth – fixed asset investment, consumption and exports – go into simultaneous free-fall.
This is a scenario that we think is unlikely to play out at this point.
Let’s look at these growth components in more detail.
Consumption
With private consumption accounting for only 35 per cent of GDP growth in 2011, the growth potential is huge.
Not only are we seeing a structural change in the way Chinese consumers are spending (from the newfound wealth of the factory worker right through to increased luxury brands), but higher wages, pro-growth consumer policies and tax reforms (business and VAT-related) should spur private spending.
Although tighter policies (especially relating to the property sector) have recently weighed on consumer sentiment and demand, retail sales are likely to deliver low to mid-teen growth this year which is still very attractive relative to other markets.
Fixed asset investment
This is assumed to be an efficient way to pump prime the economy, but this time Chinese policymakers have been cautious about approving investment-related projects.
While China’s colossal fiscal stimulus package (predominantly infrastructure-related) was warmly welcomed by global markets during the global financial crisis, it did have a detrimental impact on the domestic economy in terms of inflationary pressures.
While policymakers have been stringent about the amount of stimulus they inject into the system this year, a recent jump in project approvals highlights that external headwinds plus slowing domestic growth have perhaps been much harsher than originally anticipated.
We anticipate over the near-term that more investment-related stimulus measures will be announced.
Exports
This is the wildcard when it comes to China’s future GDP growth.
Sluggish demand from developed markets such as the US and Europe started to drag on GDP growth in 2009.
Since then, net exports have become less important to China’s economic growth profile, as shown by their limited contribution to GDP in 2010 and 2011.
Consequently, policymakers have realised they are better off looking for a more reliable growth driver for the future and the focus has shifted towards domestic consumption.
Weaker-than-expected economic data releases this year, coupled with an easing inflationary environment, have enabled Beijing to shift its policy stance towards promoting growth.
While further stimulus measures will be a positive trigger for the share market, policymakers are expected to maintain a fine balance in their policy decisions, especially as growth is likely to trough during the summer months.
From an equities investment perspective, despite increased chatter regarding China’s potential problems, we continue to find attractive growth opportunities.
For example, domestic-orientated companies are positioned to benefit from further growth policies (property, internet, service-related names).
What’s more, with investor psychology at the fear end of the spectrum, many Chinese stocks are trading at historically low and attractive multiples, enabling us to initiate positions at favourable levels.
Catherine Yeung is the investment director at Fidelity Worldwide Investment.
