One of the significant focuses for financial markets in recent weeks has been developments in China. A zero-covid policy has triggered a sharp economic slowdown and also is leading to wider contagion, as supply-chains affecting global trade are impacted. This is the latest evidence of China’s growing importance to the world economy. So, let’s look at five factors in China to better understand the implications of its decisions and how they affect the investment landscape worldwide.
1. China is a superpower, but not everyone gets to wear a costume
China is an economic superpower, second in size only to the US. Yet, its income per head is still low. Despite its huge wealth and many rich people, the sheer scale of its 1.4bn population means that its per capita income is about 81st in the world, based on IMF data, putting it on a par with economies such as Costa Rica.
This reflects the complex challenges China faces today. One of its biggest achievements has been the virtual elimination of absolute poverty, but now it needs to raise incomes further.
Yet it also indicates the potential rise in economic size and incomes that might lie ahead.
2. It is set to get economically stronger
At the turn of the century, China’s share of world GDP was only 3%, now it is about 18% and by 2030 it could exceed a quarter.
One of the most significant economic developments for China was its entry into the World Trade Organization in 2001. Its integration fully into the global trading system had a profound impact on the world economy through greater competition and lower inflation, while within China it boosted exports and growth and gave greater weight to those wanting to open up further.
I first visited China in 1994 and have been a frequent visitor since. I am positive about China’s economic prospects. One of the features that always impresses is China’s long-term economic thinking.
A reflection of this is that we are now in the early stages of China’s 14th 5-year plan, which includes a commitment to the green agenda, as China seeks to become a net-zero carbon economy by 2060.
But at the same time it is important to appreciate that its challenges are significant. Not only is its population huge but it is also ageing significantly.
It used to be said that China would be old before it was rich. There is little doubt it is rich in culture and it has also become wealthy in economic terms.
Yet, an ageing population suggests that its future rate of economic growth will be slower than in the past; perhaps nearer 5% rather than the double-digit growth rates it became used to.
This helps explain why China has been keen to move up the value curve, moving away from exporting cheap goods and instead becoming a high-tech, scientific and service-driven economy.
So far there is success. Its space programme is impressive. Chinese global brands are also becoming more common, from Alibaba, JD and Shein in retail to Tencent in media, among others.
3. China has scope to ease policy to help its slowing economy
Looking at the world economy now, China has been at a different stage of the economic cycle than other major economies in recent years.
It did not suffer a recession during the pandemic, growing 2.2% in 2020 and 8.1% in 2021, although it slowed throughout last year.
The official target of 5.5% growth for this year is challenging, although the aim to keep inflation below 3% appears achievable. In the first quarter of this year, the economy grew by an annual rate of 4.8%, although there was notable weakness towards the end of the quarter and this has continued, largely as a result of lockdowns and other measures linked to its zero-Covid policy. A significant slowdown is clearly underway, and this is also triggering supply-chain disruption, impacting global trade.
In recent years, monetary policy was prudent, and although fiscal policy was accommodative it was far from loose. Thus, China has policy room for manoeuvres to respond to its current slowdown, with policy having already been relaxed recently, and further easing inevitable.
Importantly, by next year China could reach the World Bank’s threshold for a country to achieve 'high income status', thus escaping the middle-income trap.
This will be viewed as a major achievement in Beijing, as only a decade ago economists were concerned that China might not escape this trap – where countries find it easier to move from low to middle income and then hard to progress from there.
4. Greater global integration could bring greater shocks
The biggest challenge, in my view, is this: while the trend for the economy is still up, China needs to be braced for greater future volatility. In part this is because its economy is more integrated to the global system and is thus more exposed to external shocks.
It is also, though, a reflection of the increased difficulty of running from the centre an economy that is so much bigger than before.
Hence, there is a recognition from the Central Committee, a political body comprising the top leaders of the Chinese Communist Party, that the market mechanism needs to play a greater role, especially in the allocation of land, labour, capital and technology. Although state-owned enterprises still play an important role, too.
In the past, people within China had a limited choice as to what to do with their money: place it in bank deposits, where rates were low; invest in equities, where corporate governance might be unclear; or buy property, where prices were always seen as heading higher.
Some may have taken money out of the country. Now the property bubble may have burst.
At the same time, measures are ongoing to curb corruption and improve governance. And, importantly, there is a desire to have deeper and broader capital markets.
Financial market development is seen as vital, including developing insurance markets and a more effective social safety net.
5. Safe-haven currency could be a game changer
The crisis triggered by the war in Ukraine has seen China’s renminbi viewed as a safe-haven currency. This is the first time this has happened and is a potential game changer.
It fits with the desire to internationalise the renminbi, although opening up fully the capital account still is some way off.
If the renminbi is seen as a store of value – underpinned by its central bank keeping inflation in check – then this will reinforce its attraction as a medium of exchange.
We may also be in the early stages of the great decoupling. China is keen on a multilateral system that is not dependent upon the dollar, and in which its own currency as well as others play a more important role.
The west’s decision to limit the Russian central bank’s access to its foreign exchange reserves was, like crossing the Rubicon, significant. China, like many other countries, may be wary of a system driven by western politics.
This coincides with the race to develop new global central bank digital currencies.
China’s e-CNY digital currency, already being piloted, is well advanced, while at home it needs to compete with WeChat Pay and Alipay.
Differentiation, divergence and decoupling encapsulate the present environment.
China’s economy is at a different stage of the cycle. Thus, its performance and policy may diverge from the west. And the great decoupling towards a new financial architecture has already begun, in which China will play a larger role.
Please note, the value of your investments can go down as well as up.