Investors’ have low expectations over China’s incoming leadership, Pioneer Investments
Following the appointment of China’s new political leadership by the ruling Party’s Congress, Mauro Ratto, head of emerging markets at Pioneer Investments, argues that market reactions seem to reflect some skepticism on its credentials.
We recently argued that politics could affect financial markets late this year. We referred not only to Europe’s uncertain management of the debt crisis and to the US standoff over fiscal policy, but also to China’s transition to a new leadership.
If the recent slide in Chinese stocks may provide some indications, investors had pretty low expectations about the incoming standing committee, whose members have been announced at the end of the Communist Party Congress.
The new head has long been expected to take up the top post and the same can be said about its deputy, who is poised to become prime minister and oversee the economy like his predecessors.
The rest of the team looks poised to be screened by observers in China and around the world. On the reformists’ side is probably the man who replaced the alleged former head of the populist wing.
The management of economic policy, however, seems to be on the conservative’s side, as the new prime minister is seen as standing for the (minority) populist wing. Moreover the former vice-premier, and perhaps the only member of the new committee with a background in banking, will oversee party discipline instead of finance.
Finally, two alleged reformers often quoted as candidates for the post did not eventually make it to the top committee.
It may be too early to evaluate the new leadership, although a lack of transparency in the designation process may leave analysts and investors somewhat puzzled. Some experts argue that the revered old leader, despite leaving the top job 10 years ago, succeeded in placing some of his trusted men on the new committee and this is hardly seen as an endorsement for reformers.
These misgivings may prove excessive but they are explained by China’s heightened role for the global economy, which makes it more accountable to the rest of the world than in the past. The officials’ ability in economic management is even more closely watched when concerns over the global economy resurface.
China helped the US and other developed economies overcome the US banking crisis and is urged to do the same now that new themes such as the US fiscal cliff are making headlines.
This time there is less confidence about China’s help. Fears of an economic hard landing have receded again but can hardly be dispelled as Chinese officials refrain from loosening monetary policy aggressively.
They may be held back by concerns about bank credit, whose excessive growth following easy policies led to a surge in bad loans and a long tightening round. An efficient capital market, in which truly private enterprises are not discriminated in favour of state-owned enterprises, is one of the many reforms long overdue, and this new leadership does not seem ready to undertake such a big task with a thorough commitment.
Structural reforms may be vital for China’s growth sustainability over the next decade and beyond. Those factors that propelled economic growth, such as a surplus workforce, low production costs and rapid export growth, have become less effective and the need is now to avoid the “middle-income trap” that emerging countries have fallen into when they switched to one-digit GDP growth rates.
Based on the new committee’s make-up, we expect a lot of emphasis on other forms of policy stimulus than monetary policy, such as a boost to infrastructure spending.
Admittedly, countries like China have plenty of room to act on the fiscal lever, with no need for debt de-leveraging as in most developed countries. More to the point, a more efficient railway network and other improvements of the kind will help logistics and economic growth.
However, a heavy reliance on these programs should maintain investment as a key contributor to overall growth, while reforming the economy towards a more consumption-driven growth model may bring a really structural change and some discontinuity with the past.
We believe that the new leaders’ commitment to reforms will be tested many times and also in the long run, but despite all doubts we believe that they will not slow down the current pace of reforms, set by the outgoing leadership (who is unlikely to leave the political scene altogether, too).
The case for investing in China is still very much alive and there may be more opportunities in stock picking as the economy becomes more consumer-driven and truly private are not discriminated against in getting bank loans.