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One of the biggest questions hanging over the global economy in 2019 is this: just how deep is China’s economic slowdown, and what are policymakers in Beijing prepared to do to soften the blow?
Our analysts have some answers. Their on-the-ground insights highlight clear reasons to be concerned about China’s economy, but we also identify some pockets of brightness and a heated debate over how large and how effective expected fiscal stimulus measures will prove to be.
Source: Fidelity Analyst Survey 2019.
In aggregate, our analysts report that sentiment towards China for the year ahead was both more downbeat than for other geographies and reflects a steeper falloff from 2018 than elsewhere. In the words of one Shanghai-based analyst: “Usually offshore investors have a more negative view on China but last year we saw onshore investors join the bearish group too. It was an across-the-board downturn in sentiment.”
Consider some of the surveys’ standout findings: for 2019 our analysts report that management teams of the companies they cover in China are the least confident to invest among any region globally; they are also widely expected to show the most significant reductions in capex spending, the smallest number of companies expanding headcount, and the highest proportion of companies planning increases to leverage.
Source: Fidelity Analyst Survey 2019.
One consistent refrain from the 2019 survey is that a broad-based slowdown in demand is rippling across many sectors of the economy. “The macro slowdown will weigh on the asset quality of banks, that’s for sure. In previous easing rounds we saw that China did very significant credit stimulus, but they may not do that this time,” one Fidelity analyst covering financials said.
After some modest financial easing in the past year, including several cuts to the reserve requirement ratio for banks, liquidity is generally ample in the financial system - but it isn’t making its way to end users, such as privately-owned companies.
“Interbank liquidity is fine but the issue is money is not transmitting to the broader economy. I imagine some of the heads of corporate treasury departments may be losing sleep at night,” the analyst said.
Financial stress is rising. Thirty-three per cent of China analysts expect leverage to increase at the companies they cover, while the bias in most of the rest of the world is toward deleveraging. Two thirds of the analysts who expect leverage to rise at China firms say that deteriorating cash flows are the main reason for this.
According to one fixed-income analyst based in Shanghai: “a lot of companies are already highly leveraged and facing greater refinancing risk, so now many care more about survival than growth.”
Trade war wary
Others see trade wars as a factor: “the number one issue,” says one technology hardware analyst. The timing of the tariff phase-in and potential escalation meant a lot of China’s exports were front loaded to the final months of 2018, and there have been concerns that the initial months of 2019 would show a slump. “It has brought a lot of uncertainty into the system, and I see a big slowdown in discretionary consumption and a cutoff in capex intentions as well,” the analyst adds.
Manufacturers remain a key driver of growth for the Chinese economy as a whole, regardless of whether they are exporting overseas or selling into the domestic market. And the uncertainties triggered by the trade wars mean that some will be mulling a 'Plan B', such as relocating supply chains from China to Southeast Asia.
For consumers, the uncertainties extend to their prospects for wage growth, and that has a second order effect on consumption. This can be seen in declining sales of bigger-ticket discretionary purchases like cars, or even smartphones.
Stimulus to the rescue?
Across nearly all sectors, the biggest swing factor cited by our analysts who cover Chinese companies - and potential for upside surprise - is fiscal stimulus. However, the survey results and in-depth follow-up interviews revealed diverging opinions over what shape this fiscal stimulus might take, how big the impact would be, and how much capacity the government has to boost such spending.
One analyst who covers utilities and energy says: “I think everybody is looking to China to provide a lot of fiscal stimulus, but with the background of recent tax cuts I really doubt how much room they have left for this. Already we’re at a stage where much of the high returning infrastructure has already been built; the incremental value from new infrastructure will be limited from now on.”
However, as suggested by the divergent opinions over its effectiveness, the impact of stimulus spending is expected to vary greatly by sector. “I don’t think individual tax cuts will have much of a stimulatory effect on consumer spending because Chinese tax to GDP is already very low compared to many economies, and there isn’t as much room to cut as there is in, say, the US,” says one Asia equity analyst based in Hong Kong. “It would have a one-off sugar hit impact, and then fade quickly.”
Contrast that view with the outlook for carmakers. Unlike previous rounds of across-the-board tax breaks, stimulus measures this time around are likely to be more targeted in scope, perhaps benefitting manufacturers with exposure to electric or other ‘new energy’ vehicles, or those with a stronger footprint in rural areas.
That same preference for using selective stimulus to support favoured industries or sector segments is a recurring theme in China. For example, beneficiaries of favourable policies might include new energy projects, such as distributed energy projects focused on solar power.
But the biggest direct beneficiaries of traditional infrastructure stimulus spending would still be the materials, metals and mining industries.
In recent months there was a notable increase in the number of approvals for local government infrastructure projects, as well as in the number of successful debt financing deals for local-government-linked entities. The combination of the two - financing and an official greenlight - could signal an increase in infrastructure spending as 2019 unfolds.
If that feeds through into an increase in fixed asset investment, it would be a boost to demand for industries like steel production, which tends to be a lagging indicator. Setting the tone for the year, the verdict from one analyst is that: “the outlook for the Chinese metal and mining sectors into 2019 is similar to other sectors in that it is marginally deteriorating from here.”