Many feel that China is the engine for the world economy, and worry that if it slows down, we may be doomed to a recession or even a depression. However, I don’t feel it’s time to push the panic button. Yes, China’s growth is decelerating from the double-digits of recent years; various forecasters are predicting a possible GDP growth range of 7 – 8% this year. However, I think it’s important to emphasize that would still represent an impressive pace, and remember that China isn’t the world economy’s only locomotive.
Slowing growth is a natural part of the evolution of an emerging economy, particularly one as large as China, the second-largest economy in the world. Many of the world’s economies are facing slower growth trends this year, and China is also undergoing structural changes that often come with the side-effect of a few growing pains. It has been moving toward a more consumption-oriented economic model and loosening controls on the economy, which require some adjustments. A piece of good news for China in regard to these domestic-driven efforts is that new lending during the first half of this year helped drive fixed-asset investment in China 20% higher than levels seen during the same time in 2011.1
China’s slowing growth has, of course, resulted in quite a bit of market angst, and its stock market has suffered setbacks this year. The heightened concern about the country’s recent deceleration isn’t surprising, but we must remember that there are many fast-growing emerging and frontier markets that have been powering ahead and contributing to world growth. The world economy is not a single-engine affair. According to IMF projections, Africa is expected to be the fastest-growing continent on average over the next five years. And, if India is able to engage in meaningful reform, I can see the potential for growth rates there that could echo what China experienced 5-10 years ago.
China’s Policy Toolbox
If we consider that China is a linchpin of world growth, then we must also consider what potential measures the Chinese can take to help avoid a slowdown—and I believe it has many policy tools.
For example, in recent months the Chinese government lifted limits on bank lending and on local government projects, cut loan and deposit interest rates by 25 basis points in June and cut rates again in July to 6% for one–year loans and to 3% for deposit interest rates. There have been moves to increase financing for small and medium enterprises, and, for the first time, the government has encouraged the issuance of high-yield corporate bonds on the Shanghai Stock Exchange. This is an important step since it reflected government willingness to allow more interest rate flexibility. The securities industry in China has been expanding with additional equity listings, stock options, silver futures contracts and possibly even crude oil futures in the future.
The government has also launched a round of subsidies for purchases of energy efficient automobiles and appliances, and has accelerated infrastructure projects and low-cost housing approvals.
These shifts are just some of the many tools the government has to potentially stimulate the economy, although the results might not be as immediate as other types of stimulative actions were in the past—such as massive government increases in infrastructure spending.
China also has the benefit of holding the highest amount of foreign reserves in the world (over $3 trillion) and is in control of the key banks and industrial organizations in the country. With its large foreign reserves, China has been able to learn what’s happening in Africa, Latin America, and other countries, and more importantly, buy some valuable assets that could potentially put it in good stead going forward. Recently, we learned a Chinese company struck a pending deal that could help shore up its oil and natural gas supplies via a large Canadian energy acquisition. China has been investing heavily overseas, particularly in natural resources, to help meet its growing demand.
China has been able to increase liquidity and stimulate the economy because, for now at least, inflation is on a downward trend, falling to an annual rate of 2.2% in June.2 However, wages are on the rise there, and the country faces a potential threat of rising food prices if the dry U.S. summer leads to substantially lower agricultural output. The U.S. supplies about a third of global trading in soybeans, corn and wheat, and China is the world’s largest importer of soybeans, so the impact could be substantial. Emerging countries are particularly vulnerable to food price inflation because food generally takes a larger bite out of consumer incomes than it does in developed economies. Oil prices are another factor that we think bears watching; if prices move up again the impact on overall inflation could be significant.
What else might worry me? As a long-term investor, I tend to look at the big-picture beyond short-term statistics. China’s government operates with a series of five-year plans to transform the economy, and I don’t know exactly how all aspects of the latest plan through 2015 (the 12th Guideline) will be implemented, and whether it will be successful overall. China must be able to be flexible with the program so it doesn’t make errors in its implementation. You can do your own research on the plan and draw your own conclusions, but the various goals include the aforementioned transformation to a consumption-based economic model, wage increases, tax reform and various “green” initiatives.3
Value Potential in China
As value investors, we have viewed the angst-inspired market setbacks as potential opportunities to pick up some market bargains, and price-earnings ratios are generally looking attractive to us in China right now. Consumers and commodities are particular areas of interest, because we believe a transition to a more consumption-based economy should help support these sectors. I have every reason to believe this transition should be successful, and still believe China could continue powering ahead.
You can read more about structural changes taking place in China in a recent blog from my colleague Dr. Michael Hasenstab, Franklin Templeton Fixed Income Group’s® International Bond Department Co-Director: “No Armageddon, but Consequences.”
U.S. readers can view it here.
Non-U.S. readers can view it here.
1. Source: National Bureau of Statistics of the People’s Republic of China. Stats.gov.cn.
2. Source: National Bureau of Statistics of the People’s Republic of China. Stats.gov.cn.
3. Source: People’s Republic of China, gov.cn.