I am making four predictions for China in 2021:
- Weakening of the RMB
- Weaker economic conditions
- Real deleveraging
- Pressure on local bonds.
Capital inflows have been substantial, helping to reinforce the strength of the currency. Higher domestic Chinese interest rates, the rapid quelling of the virus, domestic Chinese stimulus, the relative weakness of western economies, slight loosening of capital restrictions, and the long-term potential of the Chinese economy have made it an attractive investment destination. Foreign ownership of Chinese equities has risen 55.5 percent YoY, foreign ownership of bonds are up 37.9 percent, loans 20.2 percent, and deposits 9.1 percent.
So what are the potential problems? First, it’s likely that much of the inflows consists of repatriation of USD dollar assets owned by Chinese nationals. As western countries recover, they will be chasing short-term gains and will seek to move capital offshore once again. This is “fickle capital” as opposed to secular capital such as a fund such as Vanguard would control, and we are seeing this through re-indexing to include onshore Chinese equities.
Second, once the Biden administration takes office, because Congress and Washington in general have taken to heart the Trumpist anti-China line, multilateral approaches to reduce Chinese corporate influence will be introduced. This will increase the likelihood of long-term problems for Chinese corporates globally because a coherent international policy is likely to be more effective than the haphazard approach we’ve seen under the Trump administration.
Prediction 2: Weaker economic conditions
China has been relying on fiscal stimulus through infrastructure investment funded by bank loans and bond issuance. Unfortunately, fixed asset investment in some cases has barely exceeded pre-Covid levels. The largest increase in November was in electricity, gas and water production – these are not sectors that contribute heavily to economic growth. Construction overall was 9.2 percent lower YoY. The data for equipment utilization in China from Komatsu in Japan suggests only modest YoY increases for the 2H 2020.
Prediction 3: Real deleveraging
This has been a tough global and domestic economic environment, a signal for additional stimulus. There have been multiple interest rate cuts and cash injections into the economy in 2020, representing a withdrawal from Xi Jinping’s 2016 intent to reduce debt. He has had to face the trade war and the Covid crisis.
However, despite the backpedaling, recent statements suggest the leadership in the State Council does seem concerned about debt. The state media made this official in an article in late November. “If previous rounds of withdrawing stimulus policies are a guide, ‘tight money’ and ‘tight credit’ are inevitable, and policy rate hikes are also normal,” the China Securities Journal said. “However, we shouldn’t see the monetary authority proactively raising the policy rate for some time to come.”
Prediction 4: Pressure on local bonds
The 2009 stimulus package has left the provinces struggling for tax revenue. Land sales and one-off charges have not kept up with expenditure, sometimes directed by the central government. As a result, the provincial fiscal deficit has skyrocketed from zero in 2008 to more than 10 trillion yuan in 2019. This will lead to more defaults (or near defaults) among local government bonds, along with actual defaults among the local government financing companies that are considered part of the local government, even though legally they are private firms.
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