Anxious Assumptions

China’s Party Congress came and went with its usual mixture of banality and intrigue but this time there was mixed in some rather heady and speculative newspaper headlines. It’s always a bit of a game to try and sort out what is really going on with this important twice-decade meeting—or, to put it more accurately, to pretend that more is going on than really is.

To distill the meeting’s message into a few quick takeaways: President Xi did concentrate power more but we already knew that he would. Xi did use the term “security” a lot but in different contexts and, after all, what did you expect him to do given the recent geopolitical testing by the U.S., first on tariffs, then on semiconductors?

What went unnoticed (or was it just unreported?) was Xi’s use of the term ‘total factor productivity,’ which measures total outputs relative to the total inputs (and widely regarded as one of the main drivers of growth in an economy), together with a very non-Marxist focus on raising the quality of investment. But was that a surprise? Not to many of us here. What we did find surprising was the fall in the markets on the first trading session after the Congress. The general discussion in Asia was that the new leadership is now more hawkish—on security, on Taiwan, on zero-COVID—and now more conservative on the economy.

This knee-jerk reaction contained a kernel of truth—yes, some of Xi’s appointments do show a resolute defense of zero-COVID and an affirmation of China’s long-standing position on Taiwan. But we have to take issue with the views of many in the market that Xi’s approach to China’s economy has become more conservative. Xi’s comments at the Congress were clear and his logic is understandable. As developing nations advance, investment tends to fall as a percentage of gross domestic product (GDP). To maintain as high a growth rate as possible, China needs to be efficient in production and the capitalist market system is the best way to achieve that. At the same time, the government intends to continue to direct resources, as it has done for the last decade, to better the lives of the lower incomes in China. Xi’s socio-economic goal of ‘common prosperity’ has raised the labor share of income in China even as it languishes elsewhere in the world.

“While we are concerned about China’s zero-COVID policy and continuing tensions with the U.S. we are not concerned or surprised by the economic choices China is making.” CIO Robert Horrocks, PhD

Positive signs

So China is on a path to creating a modern welfare society and this will ultimately require changes in taxation and in the relationship between the state and its citizens. But none of these changes are novel in the context of developing nations. China will have to find its own solutions to how it plans to tax citizens more and maintain the (actually high) levels of trust it enjoys among the population.

Xi’s Congress comments also implied a continuation of investments into building the manufacturing base of southeast and central Asia. So China’s One Belt One Road cross-border infrastructure initiative will, we believe, continue. This is a positive. Yes, we are seeing some testing of the program in terms of loan forgiveness but so far the Chinese have been sensible in their restructuring efforts. And the direct and indirect benefits this will bring to other Asian nations will be significant, we believe. In Vietnam, for example, Chinese investment will not only help develop the country but it’s also likely to pay off commercially. Vietnam remains a top investment idea of ours from a top-down perspective but finding the right companies with the right liquidity is more challenging than in many other geographies although this is improving over time.

India is already a beneficiary of the program. There was a time when we thought that One Belt One Road might pass India by and leave it isolated but it has perhaps become a part of the motivation for India to improve its infrastructure and to support manufacturing export growth. Manufacturing exports have surged post-lockdown and, together with the stability of India’s current account in quite a difficult economic climate, are testimony to the country’s macroeconomic reforms. These changes seem to be spurred by a realization by India that it needs to connect better with the world commercially rather than see Chinese-financed construction spring up all around it.

So while we are concerned about some of the headwinds and challenges China is facing, including its zero-COVID policy and continuing tensions with the U.S., we are not concerned or surprised by the economic choices China is making, as alluded to by Xi at the Congress. China’s COVID approach continues to be the policy that is having the biggest drag on the Chinese economy and for now there seems to be little near-term prospect of a significant loosening of this policy. Similarly, we expect China’s tensions with the U.S. over Taiwan and its relations with Russia to continue. But we see China’s long-term economic trajectory, on the other hand, as being unchanged, robust and predictable.

Robert Horrocks, PhD
Chief Investment Officer
Matthews Asia