Follow the leader

At the end of a dramatic year, some observers think China could lead the world out of an economic slump. We asked the financial community for their views.

2020 will stand out as a year of transformation for the financial services industry, driven by a global health crisis and an economic contraction more radical than anything witnessed in almost 70 years.

For China, its effects will be particularly significant, since it was impacted early by the pandemic but also one of the first countries worldwide to emerge from lockdown restrictions.

Importance_of_ChinaThese momentous developments have been superimposed on to longer-running uncertainties deriving from ongoing trade tensions between the US and China, the impact of a new national security law in Hong Kong, and the decision of a number of Western governments to exclude Chinese telecoms company Huawei from their 5G telecoms infrastructure.

Against this background, the survey reveals that the confidence of foreign investors in the Chinese market remains strong and that they continue to identify compelling opportunities for investment. More than 76% of respondents said that China’s strategic importance in their global investment strategies has risen over the past 12 months and 17% highlight China as ‘top priority’. In contrast, only 1% say that China’s importance has declined over the past year.

There is optimism that China may lead the world economy out of this slowdown. China grew by 3.2% y-o-y in Q2 2020 – reversing a 6.8% decline during the preceding quarter, according to data from Trading Economics – the first major economy to report growth as it reopened manufacturing and retail outlets after the Covid lockdown. Quarter-on-quarter, China’s Q2 seasonally adjusted growth of more than 11% was the strongest on record. 

Challenged by fears of global recession, low interest rates and a weak outlook for dividends, investors are looking to China in their search for yield. Chinese equities market have performed strongly during Q2 and Q3, with the Shanghai Composite up almost 10% year-to-date. In contrast, the MSCI World has fallen 2.4% over the same period. So too in fixed income markets, where Chinese government bonds offer attractive yields relative to their equivalents in other large global economies.

Institutions_investments_in_ChinaThe survey results indicate that investors have been reassured by ongoing steps by Chinese policymakers to liberalise access to the Chinese market and to reform access channels. Stock Connect and Bond Connect are the access routes of choice for many foreign investors, although the lifting of quota restrictions in the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) programmes (known as Qualified Foreign Investors, QFI, as of November 1, 2020) demonstrates that the Chinese authorities are eager to reform across a broad range of entry points. This is illustrated further by the publication of a consultation paper by the China Securities Regulatory Commission (CSRC), the People’s Bank of China (PBoC, the central bank) and the State Administration of Foreign Exchange (SAFE, the foreign exchange regulator) on September 2, 2020, proposing further changes to the functioning of China’s bond markets.

Sceptics might identify a mismatch between this strong investor sentiment towards China and uncertainties prevailing in both the global macroeconomic and domestic political environment. However, it is evident that investors are in no way ignoring these risks. Respondents highlight concerns about the domestic political/economic environment and the continuation of US-China trade tensions as the top two criteria that are steering their investment strategy towards China. Investors are evaluating these risks and believe that the potential growth opportunities present a strong secular case for investment in the Chinese market.

China’s importance as an investment market
The survey results are striking when it comes to the rising importance of China in the eyes of international investors (fig 1). More than 90% of respondents say that the importance of China continues to rise, with 17% of these saying that China holds top priority in their investment strategies. Only 1% say that the importance of China has declined over the past year, notwithstanding US-China trade tensions and global economic uncertainty associated with the Covid-19 pandemic. 

China_bond_markeExamining the impact that this positive investor sentiment will have on fund flows, 47% of respondents said that their institution (or their investor clients) will increase their investment to China during the 12 months ahead (fig 2).

Significantly, given current uncertainties in global investment markets, a further 12% said they will invest in China for the first time. In contrast, only 6% indicated they will reduce their investment allocations to China over the coming year.

Simon Kellaway, Regional Head of Greater China and North Asia Financing and Securities Services at Standard Chartered, said: “These results highlight a positive outlook for China that aligns with what we are seeing on the ground. Despite the headwinds created by the Covid-19 pandemic and global economic slowdown, the survey predicts growth in domestic and cross-border investment that exceeds our internal predictions.”

Driving this optimism is a belief that China will play a key role in leading the global economy out of its Covid-19-induced slowdown. The Chinese economy grew by 3.2% y-o-y in Q2, according to Trading Economics, making it the first major economy to report growth after easing its lockdown restrictions. Quarter-on-quarter, the Chinese economy grew by a seasonally adjusted 11.5% in the three months to June 2020, following a revised 10.0% contraction in the preceding quarter. This was the strongest pace of quarterly expansion on record, boosted by improving demand in the domestic economy following the easing of movement restrictions.

Factors_influencing_China_investmentsConfronted globally by low interest rates, weak dividend forecasts and fears of recession, investors are turning to China in their search for yield (see fig 3). “For fixed income investors, China’s bond markets offer attractive yields relative to their equivalents in other large global economies,” says Kellaway. The Shanghai Composite has risen 9.86% between January 2 and September 18, 2020 and this compares well with many equity markets around the world. “The survey also demonstrates that investors are excited by new investment opportunities in China, particularly those in private markets,” adds Kellaway.

Ease of access a priority for investors
Survey responses indicate that it is becoming easier for foreign investors to access the Chinese market, both through onshore and offshore channels. China’s regulators have taken steps to streamline the QFII and RQFII programmes (known as Qualified Foreign Investors, QFI, from November 1, 2020) and to broaden access to China’s domestic bond markets through China Interbank Bond Market (CIBM) Direct.

This has been a prime factor driving respondents’ decisions to invest (or to increase their investment) in China: 69% highlight ease of access to onshore channels and 63% highlight ease of access to offshore channels (e.g. Stock Connect, Bond Connect) as key to driving their investment strategies in the Chinese market (fig 4).

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