17 Dec 2019
China’s economic growth rate continues to decline – it’s expected to be between 6.1% and 6.2% this year. Assuming there is neither a comprehensive trade deal with the US (beyond the recently announced interim deal) nor a meaningful easing of policy within China, growth will likely soften further, as the tailwind from this year’s tax cuts recedes and the impact of tariffs weighs more heavily.
Yet investors have reason for some seasonal cheer. Our trip left us with the view that China’s ambitious 10-year goal of doubling GDP per capita – set in 2010 – is still achievable.
Based on our meeting with a government think-tank, we think China will target 2020 growth of “around 6%” when it announces its economic ambitions in March. This would give it a bit of room to undershoot 6% without that being cause for alarm.
If annual growth of 6% remains the goal and a comprehensive, long-term trade deal fails to materialise, investors should expect more expansionary policy. That said, unless growth momentum falls towards 5%, major stimulus measures seem off the cards.
Either way, during our trip it was very clear that when considering the scope and design of policy easing, two key priorities for policymakers are property market stability and the environment.
As we wrote earlier this year, China has learned from past mistakes, whereby a focus on quantity of growth over quality led to overheating and culminated in a painful correction.
As for environmental policy, China has ramped up considerably its efforts in the past few years, with tightly policed restrictions aimed at getting businesses to clean up their act quickly. This demonstrates China’s recognition that environmental standards are a key area of weakness and its seriousness in addressing this. We think that is further reason for investor optimism.
All the companies we met during our visit demonstrated an impressive improvement in their leverage over the last three years, with debt-to-asset ratios down across the board. It feels like they have reached levels they are generally comfortable with now, so the pressure to de-lever should reduce.
This is consistent with a view our colleague Victoria Harling shared recently: while many developed market companies have continued to increase their indebtedness, leaving them vulnerable to a downturn in fortunes, emerging market companies have done exactly the opposite over recent years.
We also came away from China really impressed by the transformational reforms we saw among its state-owned enterprises.
One major metals producer we met with had been loss making a few years ago with a debt-to-asset ratio of over 100%. Following a takeover in the form of a joint venture – with the financial backing of a major foreign private equity firm – this has shrunk to below 30%. The organisation has also implemented a more flexible labour policy, along with a management stockholding scheme to better align the interests of management and shareholders.
We think this SOE turnaround model could well be rolled out more widely across China, to the potential benefit of both debt and equity investors.