Outlook 2022: China

China led the macroeconomic recovery from the initial outbreak of the pandemic. However, regulatory reforms, the energy crisis and real estate volatility as a result of regulatory actions and concerns over real estate developers, have proven additional issues for markets to negotiate. And this led to some contrasting performance between bond and equity markets in 2021.  

There are multiple considerations to weigh up for 2022. Can slowing economic growth begin to ease; and are regulatory pressures set to lessen?

China’s economy

David Rees, Senior EM Economist

The sharp slowdown in China’s economy that began in the second half of 2021 will spill over into 2022.

While the government’s zero-tolerance Covid-19 policy remains in place, restrictions to contain outbreaks of the virus will continue to periodically hit activity. Government intervention has greased the wheels of the energy sector after blackouts hit activity. Even so, coal reserves are likely to remain stretched through winter at the very least. As a result, manufacturers face higher energy costs at a time when demand for exports looks set to soften.

However, it is the real estate sector that is of most concern. A crisis of confidence regarding the health of highly indebted developers has caused sales of new property to dry up, taking away a key source of financing and leading to a downward spiral of weaker construction activity, more debt restructurings and weaker sales. But the authorities are likely to step in at some point to steady the ship. Even so, the lags between weak sales of land and new properties and activity mean that construction will be weak in 2022.

We will also be looking for an upturn in leading economic indicators for signs of future improvement. For example, while the credit impulse continued to decline in October 2021, signalling soft economic conditions into the summer of 2022, it did so at a slower pace. The impulse may trough and pickup around the turn of the year implying an improvement in activity in the second half of 2022.

China equities

Louisa Lo, China Fund Manager

It’s hard to gauge timing on China reopening its borders, given its zero-tolerance stance. As a result, the recovery in consumption is likely to be domestic-led, which should pick up as Covid eases on the back of strict measures and higher vaccination rates.

Producer price, or factory gate, inflation may peak in 2022 thanks to industrial normalisation globally. Overall supply chain improvement is also expected in 2022, as we do not expect any severe lockdowns in any major economies. More importantly, select consumer companies with strong brand power may be able to pass through high input costs to end consumers amid a better consumption environment. So 2022 could be a better year for high quality consumer stocks.

While producer price inflation may peak soon, it is unlikely to retreat to a significantly lower level. China is heading into a period of structural inflation, driven by longer term factors such as an ageing population, the focus on decarbonisation, and the continued and prolonged quantitative easing around the world.

We expect new infrastructure and green-related capital investment to be the key areas of growth, in line with the country’s policy direction. Traditional infrastructure investment may increase modestly on the back of more supportive fiscal policy next year, but we do not expect a massive jump as local governments will also need to follow the country’s broader debt reduction efforts. On the other hand, the slowdown in property investment is likely to continue given the ongoing property market deleveraging.

Although supply-side bottlenecks may be resolved next year, exports may slow in 2022 as the tailwind of overseas lockdowns fades. This reinforces the importance of dual circulation; the emphasis on longer term exports growth while also promoting domestic consumption, localising research and development, and boosting import substitution. As such, domestic consumption is likely to be a key growth driver from 2022 onwards.

The policy direction is clear, with debt reduction and narrowing income disparity the top priorities. The policies can be fine-tuned if necessary but will not be reversed, in our view, as a long-term shift in economic drivers and de-risking are still the focus of policymakers.

The correction in Chinese equities in 2021, which has seen valuations for many popular stocks pull back sharply from elevated levels, is throwing up more interesting opportunities in a variety of sectors. We believe overall market valuations are healthy, despite some significant differences across sectors, and provide more downside protection amid the still challenging macroeconomic environment expected in 2022.

China debt

Julia Ho, Head of Asian Macro

Although we may not see a repeat of the strong relative outperformance of 2021, we remain very bullish on Chinese onshore bonds going into 2022.

China’s economic growth has decelerated from high single-digit growth rates over the past decade to a projected 5% in 2022, as China shifts its economic focus from the quantity of growth to the quality of growth. The slower overall growth rate is positive for bonds, as interest rates are likely to remain low.

While global central banks are ending quantitative easing programmes or beginning to hike interest rates, China stands out as the only large central bank to have eased monetary policy recently. This stance means there is likely limited downside in Chinese bonds, providing a favourable medium-term risk-reward profile.

Secondly, the new themes of common prosperity, regulatory reform, and deleveraging are all supportive of bond investments.

Finally, Chinese bonds as an asset class have come of age, as investors are starting to view them as an emerging safe-haven asset. The outperformance during the pandemic in March 2020 and amid the global bond rout in the first quarter of 2021 demonstrated the resilience of China bonds. Attractive valuations, a supportive economic backdrop, divergent monetary policy, growing accessibility, ongoing index inclusion, low volatility, and diversification benefits are just some of the reasons we continue to favour China bonds.