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Will strategy of de-risking China work?

Chew Sutat
Chew Sutat • 10 min read
Will strategy of de-risking China work?
China is forced to rely less on exports and depend more on domestic consumption to drive economic growth. However, confidence is low for now / Photo: Bloomberg
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There is nothing like taking the pulse of the ground while standing from a floating vantage point. One of the highlights of my recent week-long trip to China was visiting one of the mega yards operated by Yangzijiang Shipbuilding where container ships that can carry up to 24,000 TEUs, or 20-foot equivalent boxes, are being built.

From the bridge of one of those ships docked along the Yangtze River where the yards are located, it was a sight to behold. There was a constant buzz of activities as the company works towards fulfilling its bulging order book of some $20 billion. I was told the yards, which will be full till 2026, could have built ships of a bigger size, if not for the need to keep to within 399.9m dictated by the width of the Suez Canal.

Besides flexing the industrial muscle, the yards are demonstrating their ESG chops too, as many of the new orders are for LNG-powered vessels. In the company’s museum, I saw photos of myself, marking the occasions I was there in 2007 when Yangzijiang Shipbuilding launched its IPO, 2017 when the Straits Times Index (STI) component stock marked its tenth anniversary on the Singapore Exchange (SGX), and more recently, when Yangzjiang Financial Holding, its investment arm, was spun off in a listing last April and where I now serve as its lead independent director.

Another highlight of my visit was joining the National Day celebrations organised by the Singapore consulate in Shanghai. Despite many having returned home during the pandemic years, some 300 pink IC holders and their friends came together for the occasion.

China’s shipbuilding industry, which benefits from cheaper input costs in a deflationary environment and a depreciating renminbi, is but just a handful in China going gangbusters at the moment.

Unfortunately, many sectors are not exactly in the same happy mood. Official figures — often assumed to be over-cheery — have shown imports and exports for July contracting 12.4% and 14.5% y-o-y respectively. Consumption remains anaemic. Meanwhile, youth unemployment figures are hovering at a worrisome 20% and further disclosure of this particular statistic has been suspended. While market watchers frown, China’s 11.6 million graduates a year will perhaps be more motivated to become wang hongs or “online celebrities” given limited job prospects beyond the gig economy.

See also: Bank of England revives speculation of UK rate cut this summer

Meanwhile, it was remarked that in some institutions, there are more PhD candidates than students. Both groups are in no hurry to finish school. Hardly reassuring too is the news that leading developer Country Garden is tottering under its debt load of RMB1.4 trillion ($260 billion).

With slowing growth and dangerously low inflation, China’s economy, which reopened from the pandemic belatedly, is poised for stagnation with growth expected at merely 0.8% for the April to June quarter. Western economies, meanwhile, are grappling with high inflation and rising unemployment.

US President Joe Biden’s use of a “ticking time bomb” to describe China and its economic challenges before adding the remark that “when bad folks have problems, they do bad things”, did not go well in the country. With the US presidential cycle back in full swing, these comments and those to follow will ironically unify the Chinese more so than Xi Jinping’s economic policies, which have garnered much criticism in private. However, by putting curbs on the sale of chips, restricting investment flows into the country and forcing companies to adopt “friend-shoring”, it can be objectively pointed out that it is the US which is trying to contain China’s inevitable growth. And in a beggar-thy-neighbour de-globalised world, who ultimately gets hurt? More about this later.

See also: When, oh when, will the stock market be revived?

Macro vs micro
Apart from struggling to get connected to local apps (“Shanghai Surprise”, Chew On This, Issue 1099) on my phone, one of my first observations, corroborated by friends who travelled separately this time, was the clear summer skies, air and reduction of ambient constant noise from traffic. It could be the absence of 5 million people (locals and foreigners) who have left Shanghai or the alleged industrial slowdown around the manufacturing-heavy Zhejiang province or the fact that electric vehicle makes up about a third or half of traffic.

In this regard, the Chinese government’s stress on green technology, leading to more rapid adoption than the West, is showing encouraging signs. Instead of China, the major cities of Indonesia and India are now the ones with the worst air pollution. EV technology, infrastructure and adoption, just like the rapid expansion of the digital economy, has created a form of economic efficiency and vibrancy, which is sustainable and inclusive. This is likely to differentiate China from the ancient regimes of Europe and the US which view central planning with some disdain. If jobs are limited in Chinese cities, there is still the farm to go back to and the Asian family support to rely on.

In addition, with strict controls and digital monitoring which is anathema to Western liberties and freedoms, crime is low in China. One feels generally safe walking both along The Bund in Shanghai, which is thronging with tourists, as well as in the rougher districts. This compares with the escalating drug, opiate and crime problems plaguing San Francisco and many other US downtowns.

China’s policy shift towards domestic consumption and dual internal circulation to make it less dependent on exports is right. However, it will take some time to achieve and remove its dependence on being an export-led economy. Household wallets are constrained by the property slump. Local government pockets are similarly constrained, saddled with debt and unable to rely on land sales to generate revenue. For consumption to thrive and act as a shot in the arm for the Chinese economy, these debt albatrosses have to lift. Having let the property sector undergo a correction — a painful but necessary pill to swallow to ensure resources are not directed to unproductive real estate speculation — banks are now being encouraged to lend.

It is hard to envisage where the bottom of China’s economy is but we are closer to it now. Having said that, this bottom may last several years. There is talk that the bad debt borne by the local government may be restructured by the central government in Beijing to kickstart necessary spending. But this is only conjecture and hearsay. If similar restructuring vehicle like Huarong in the past that took on bad debts held by banks are set up, then the revival of zombie banks that took place could similarly be engineered for local governments.

Aside from shipbuilding, travel is another sector that is doing very well. Just look at the summer holiday crowds in Shanghai from other Chinese cities and provinces. In contrast, with reduced flights and visa curbs, international travellers are much less visible.

Ctrip, which also owns Trip.com and Skyscanner, and other travel apps appear to have recovered beyond pre-pandemic numbers, and are struggling with capacity. In this regard, it is not surprising that SGX-listed Straco Corporation, which owns the Shanghai Ocean Aquarium and several other attractions in China besides the Singapore Flyer, on Aug 14 reported earnings of $6.4 million for its 1HFY2023 ended June 30, reversing from the $8.5 million loss a year earlier.

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In the same vein, low to mid-end domestic consumption has been holding up. Sasseur REIT, which owns a portfolio of outlet malls in Tier 2 and Tier 3 Chinese cities offering discounted luxury goods, is pitch-perfect. Tenant sales for its 1HFY2023 were up 8% y-o-y, surpassing pre-pandemic levels. Coupled with a yield of above 8%, Sasseur is showing why it is the best-performing SGX-listed Chinese REIT. With investors and analysts discounting overseas-listed China companies or those with exposure to its economy with a broad brush, there are opportunities to buy growth at very good value if one cares to look.

Confidence misplaced
It is clear that the Chinese economy is going through a painful period due to its structural adjustment and forced decoupling from the West. However, even if the property and local government debt situation drags on, this period of rebasement will find its feet and resume its canter eventually. The key issue is confidence, which is at an all-time low in all my 20 years of visiting China despite the 31-point plan announced by Beijing recently to support business.

During the pandemic, many successful businessmen left China and Hong Kong and not many seem to be returning — at least not their overseas assets and wealth. Competition, especially in the digital economy, is intense. With common prosperity, many owners of domestic businesses have come to expect that single-digit margins are more realistic and sustainable. To grow businesses with double-digit margins, they have to look outside China into South East Asia.

There is even fear among bankers in lending to the private sector, lest they get called up to account personally for decisions that seemed to be correct up to 20 years ago. Yet, this is what is holding up the economy, irrespective of the direction from the top now that it is ok to support unfavoured sectors like property. As a bank employee would you take the personal risk? In that case, it would be better to join the public sector and tang ping or “lie flat” in an act of self-preservation.

In my opinion, China’s current downturn will not last indefinitely. The country’s demographic dividend will continue to provide a strong driving force for domestic economic growth and a more stable society will emerge although growth will return but not the unsustainable breakneck growth of the 2000s. From here on, I will look to buy Chinese ETF at dips, after selling the Covid rebound that peaked during the Lunar New Year.

Looking further ahead, China’s economy may now not overtake the US in a decade as previously forecast. But it may still do so in 20 years even with the containment by the West in full swing. A restructuring to rely less on exports and to stress more on economic growth led by domestic consumption will support Chinese ETFs that have broad exposure. More interestingly, The Economist on Aug 9 argued that Biden’s latest rules to police investments and ban investments in sensitive technologies — all designed as economic weapons against China — will ultimately fail.

De-risking from China and friend-shoring was meant to help America build supply chain resilience and protect national security. Unfortunately, supply chains have become more tangled and opaque. Statistics indicating imports to the US from China have shrunk by a third since 2013 need a deeper look. This includes the economies of Mexico, India and Southeast Asia that supposedly gained from the realignment as they are often but transit points for trade flows between China and US. Research from the IMF shows that even in advanced manufacturing, countries that made the most friend-shored inroads are those with the closest industrial supply chain to China.

Credit goes to the flexibility of free markets, which has the effect of building friendships along with trade links, never mind geopolitics. Ironically, the US policy of containing China may end up hurting itself. Whatever the case, my Chinese portfolio allocation will gradually increase.

Chew Sutat retired from Singapore Exchange after 14 years as a member of its executive management team. During his watch, the exchange transformed from an Asian gateway into a global multi-asset exchange, and he was awarded FOW’s lifetime achievement award. He serves as chairman of the Community Chest Singapore

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