Headwinds temper China’s growth

By Jayson Forrest - Managing Editor  - IMAP Perspectives

As China is poised to take over the U.S. as the world’s largest economy potentially within a decade, international pressure, particularly from developed countries, is increasing on China to allow its currency to appreciate, thereby putting it on a more level footing with other countries.

Head of Client Service and Marketing at Western Asset Management, Jonathan Baird adds that as China transitions to a developed country, it is focused on its own economic and financial stability, and is therefore mindful of how it eventually does that, particularly as it emerges from a period of challenging U.S./China relations.

“So, any escalation of geopolitical or trade tensions doesn’t help China,” says Jonathan. “Moving forward, tensions and challenges with China will continue, and there is likely to be more seemingly irrational decisions coming out of Beijing. However, if there is any sense of rationality with the Chinese government, then we are unlikely to see a full escalation of conflict that might affect its focus on internal growth and financial prosperity.”

Jesse Imer, a Fixed Income Investment Strategist at Mason Stevens, believes that China’s rising military power and its aggressive posturing over territorial disputes in the South China Sea, as well as with Taiwan, is undeniably building tensions between the U.S. and China.

“There are a lot of variables to consider with China. I do hope that with our relationships with both the U.S. and China, we don’t get to the stage where it’s a case of either you’re with us or against us,” Jesse says. “There’s always going to be a lot of nuances with U.S. and China relations, like the concern of developed nations with addressing China’s theft of intellectual property. That’s going to be a very big and ongoing topic over the next couple of decades.”

However, with China forecast to become the world’s largest economy within the next 20 years, building mutually respectful relationships with China will become increasingly important.

“If China does overtake the U.S. as the world’s largest economy, then China will have increased bargaining power on the global stage, and businesses that want to tap into this growth or enter the Chinese market, may have to ‘play ball’ with the way China operates, because China will be protected by its sovereign rights within its own borders,” says Jesse.

“That means there may be significant ‘give and a take’ over the next 20 years, where developed economies may have to concede certain points with China in order to tap into its economy.”

Jonathan believes the outlook for the Chinese local currency bond market is strong, with China bonds potentially becoming as big as U.S. Treasury bonds.

“The Chinese bond market is well on the way to becoming as big as U.S. Treasury bonds,” says Jonathan. “The growth in the Chinese bond market over recent years has been absolutely spectacular. And now we’re even seeing China included in a number of indices.”

According to the CEO of Douglas Funds Consulting, Nigel Douglas, China does hold a significant amount of U.S. Treasury bonds, which links China economically through the financial systems of the U.S. and Western countries, just as it is tied to these markets with trade.

With an ageing population that is unable to be supplemented by immigration, China is facing its own demographic headwinds. But is the continuing upskilling and relocation of rural workers to the cities, enough to keep the Chinese economy growing?

“It’s a good question,” says Jesse, who believes one of the greatest challenges for China will be the speed and rate of change in which China can move people from rural areas into secondary and tertiary industries to help support the country’s economic growth.

“In China’s case, most of its ageing population hasn’t been working in these secondary and tertiary industries. Instead, we’re seeing the ageing population being replaced by a younger cohort of workers who, instead, will be employed in these secondary and tertiary industries.

“A sensitive issue for China will be the rate of change concerning the urbanisation of its population, by moving people from agrarian and rural areas to China’s eastern cities. And by doing so, they will join the global labour force and consume more, which is what the domestic economy needs. That’s because China is becoming a more consumption-based economy, meaning there will be ever-increasing demand for both local and foreign goods.”

However, Jonathan takes a slightly different view, comparing China to the economic development of Japan.

“Culturally, the consumption of goods isn’t as big in Japan as it is with Western countries. And looking forward, perhaps this will be a similar pattern for China. Ultimately, we’re seeing China ramp-up its efforts to become a developed nation, but there is usually a natural flattening out that happens as a result of this, which may affect its economy,” Jonathan says.

“There are definitely headwinds coming for China and how the Chinese government addresses those headwinds will be interesting.”

In contrast, Nigel believes that China is rapidly pushing ahead with technological change and development, already making great advancements in areas such as robotics. He suggests that with these developments and changes, China is well placed to adapt to any headwinds caused by an ageing population and any shortfall in the labour force as a result of that.

Nigel Douglas is CEO of Douglas Funds Consulting; Jonathan Baird is Head of Client Service and Marketing at Western Asset Management; and Jesse Imer is a Fixed Income Investment Strategist at Mason Stevens.