China’s turnaround – business as usual?

The start of 2021 in China appears to be the polar opposite of last year. Whereas last year the economy was reeling during the first quarter, reflecting the start of the Covid-19 outbreak and the growing implementation of restrictive measures to combat its progress, this year its economy seems to be thriving. Both its GDP and export growth have resumed their pre-pandemic trajectory, placing China in stark contrast with most Western economies which are still stuck in the Covid-19 doldrums. Does this economic turnaround mark a return to China’s seemingly unstoppable rise to world economic dominance?

As ever, a peek under the surface of the headline numbers indicates a slightly different story. While there is no denying China’s economic momentum is leagues above other nations, growth is now being powered by different drivers than before the pandemic. The push towards increased globalisation has ground to a halt, with many governments and businesses seeking to broaden supply chain resilience and ease their prior reliance on Chinese production. And China’s authoritarian behaviour is drawing increasing criticism from global trading partners, who may be drawn into a more collaborative and united resistance under a Biden administration.

China will undoubtedly remain an economic force in 2021 but may not have everything its own way.

China GDP may have posted its first contraction in over 40 years in Q1 2020, declining 6.8%, but its recovery has been robust and rapid. China’s economy grew more than expected last year as the economy expanded by 2.3% in 2020 compared to a year earlier.¹ While compared to its recent norms, this figure may seem low, China was the world’s only major economy to deliver positive growth for the year 2020.

And while the encouraging roll-out of Covid-19 vaccinations should help deliver more widespread economic expansion this year, growth for many Western economies was more modest. On the other hand, the World Bank is currently forecasting China GDP growth to be near 8% in 2021², which would surpass its pre-pandemic level.

15 economies expect to account for 74% of global growth in 2021

While the headline numbers suggest the economy is back to business as usual, there are indicators to suggest the game has changed. Historically, Chinese growth was driven by infrastructure investment, but this model shifted towards consumer spending under Xi Jinping in recent years. Yet, during 2020 this trend seemed to unwind. It was industrial production – benefiting from state support and lockdown relaxation– that provided the economic power, rising 7.7%, while retail sales disappointed and fell 3.9% for the year 2020³ as it took longer to regain household’s confidence amid the pandemic.

Retail will rebound but this suggests that even in China, some consumer-facing businesses may struggle in a post-pandemic world. A 2020 rise in unemployment⁴ and a squeeze in household budgets⁵ points to the likelihood that consumption growth will take longer to fully recover.

So, the health of the domestic economy remains mixed, but what of China’s relationship with the rest of the world?

China recorded its highest-ever monthly trade surplus in December, with global exports surging 18.1% year-on-year and exports to the US up 34.5%⁶. However, again the headline numbers seem to flatter and disguise longer-term trends that may not be quite so favourable.

The export bonanza to largely Western economies has been particularly pandemic-related, dominated by sales of personal protective equipment and working from home technology⁷. At the same time, demand from many other sectors has been depressed thanks to the worldwide economic slowdown. These should be short-term trends. Controlling the Covid-19 virus will likely slow demand for personal protective equipment, but as the world goes back to normal and economies return to growth demand for other China exports may not resume.

The combination of trade tensions during the Trump years and recognition during the pandemic that there is an over-reliance on Chinese goods has prompted governments and businesses alike to diversify their sourcing networks. While a full decoupling from China is considered unlikely, a strategy known as ‘China Plus One’ is expected to broaden global supply chains to incorporate more countries and sources for goods.

An array of political disputes with China also means that going trading relationships cannot be taken for granted. The tit-for-tat imposition of tariffs between the Trump administration and Beijing garnered most attention, but questions about how to deal with China’s dominant economic position and authoritarian governance are being raised beyond the US.

In November 2020, the European Union (EU) published a paper entitled ‘A new EU-US Agenda for Global Change’,⁸ raising the need to defend against ‘authoritarian powers’ and ‘closed economies (that) exploit the openness our own societies depend on’. In this veiled reference to China, the paper envisions enhanced cooperation with the US to shape the digital regulatory environment, antitrust enforcement, data protection, foreign investment screening and cybersecurity.

Yet such interventions are not generally well received by Beijing. Australia’s call for an inquiry into the origin of the Covid-19 outbreak led to China imposing punitive tariffs on a number of Australian products, which threatens this valuable trading relationship which was worth USD $103bn in 2019⁹.

Even so, the opportunity of trading with China remains highly prized. A free-trade deal between 15 Asian nations, including Japan and South Korea, the Regional Comprehensive Economic Partnership (RCEP), was signed in November. And despite its misgivings, the EU agreed an investment deal with China in December.

It seems clear that a more coordinated international response to deal with China is needed. Enter President Joe Biden…

The incoming Biden administration will have a lot of plates to spin, both domestically and internationally. Yet, the US relationship with China will undoubtedly be one of its top priorities – the new US Treasury Secretary and former Federal Reserve chair, Janet Yellen, has already named China as ‘our most important strategic competitor’.

Any hopes Beijing might have of Biden being a soft touch are likely to be short-lived. He is expected to retain his predecessor’s hawkish stance towards China, even if he doesn’t mimic Trump’s tariff-centric approach. And he is also surrounding himself with a highly capable team. Alongside Yellen, he has appointed Katherine Tai as Trade Secretary, a Yale and Harvard alumnus, whose parents were born in China and is a highly experienced trade negotiator who spent years during the Obama administration fighting trade complaints against China.

Biden will also need to court his allies. The collective might of a truly united Western alliance might just be strong enough to take on the growing dominance of China.

While China continues to present many political, business and ideological challenges, it is hard to deny that its economy boasts great potential. The clash between deglobalisation and domestic market opportunities might appear unstable, but at BNP Paribas Asset Management, we believe that instability leads to opportunity.

As the wider global economy starts to recover, China’s strong export outperformance may lose some steam, and the government is expected to extend its growth plan, driving investment openings across a swathe of consumer-orientated industries.

China’s recent commitments to improve its environmental credentials will involve massive infrastructure investment, as will its efforts to improve domestic telecoms and connectivity. Such vast spending programmes will create a multiplier effect for investment opportunities, across multiple sectors.

And the Chinese equity market is becoming more accessible for international investors, via both internationally traded shares like on the Hong Kong Stock Exchange (known as ‘H’ shares) and the onshore domestic Chinese equity market (‘A’ shares) listed in Shanghai and Shenzhen. Moreover, because China remains significantly under-represented in global indices, and because the country is often exposed to different market conditions, Chinese equities are considered highly complementary to a broader global equity portfolio.

We maintain a cautiously optimistic outlook for risk assets over the medium term and remain committed to looking beneath the surface of developing opportunities in China to find the best prospects for our clients.