Fears that China has become ‘uninvestible’ are overblown – it is not Russia

While pandemic woes and rising commodity prices have shaken investor confidence in China, it remains an open, globally accessible and growing market
The real unease stems from Beijing’s regulatory uncertainty, but policymakers have caught onto this and promised relief

Aidan Yao

Published: 4:30pm, 1 Jun 2022

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A confluence of adverse forces has made investing in China challenging in the past 15 months. The brutal selling in certain parts of the equity and credit markets has eroded asset values at a speed and scale rivalling some of the worst market drawdowns in recent history. Confidence has depleted, so much so that some investors have started to question the investment potential of the Chinese markets.

“Is China still investible?” has, therefore, become a serious question to ponder. Answering it may require examining three key dimensions.

The first is the economic dimension: has the macro environment, within which companies operate and assets are created, changed sufficiently to challenge one’s investment thesis? Such a change might be a drastic deterioration in the country’s long-run growth potential, which could impact the future stream of income generated by assets.

Or it could be a substantial increase in economic uncertainty that clouds the outlook of corporate earnings (relevant for equity), business survival (important for credits) and income generation of assets (like real estate).

An obvious example of a market that has become uninvestible recently is Russia, whose economy has been brought to its knees by Western sanctions and international isolation of its products. To the extent that these will have a lasting, but highly uncertain, consequence on Russia’s long-run economic growth, many investors may want to steer clear of Russia’s assets until the dust settles.

The Chinese economy is currently in a difficult spot, plagued by the pandemic, property market woes and high energy prices. However, it is questionable how long-lasting these forces will be, and to what extent they will inflict damages on China’s long-term growth outlook.

Immigration officers in protective clothing check a tanker carrying imported crude oil at the port in the Chinese city of Qingdao on May 9. Photo: China Daily via Reuters

The market consensus expects China to recover from below 5 per cent growth this year to 5.2 per cent in 2023 and 2024. This may represent a downward revision to China’s potential growth of around 5.5 per cent before the pandemic, but such a small adjustment – which is directionally unsurprising – is hardly a reason for declaring all Chinese markets uninvestible.

Second, certain changes to financial infrastructure can make a market difficult to access and transact, undermining its investibility. This does not appear to be a problem facing China. It is true that the Chinese markets are less open, in an absolute sense, than developed markets due to capital controls and a lack of full convertibility of the yuan.

However, one cannot deny that the markets have become more liberalised over time to foreign investors, making it possible for renminbi assets to be included in global indices.

There has been no back-pedalling on market liberalisation in the past two years that prohibits the buying and selling of Chinese assets. In fact, the sizeable capital inflows since the second half of 2020, followed by some modest outflows recently, suggest that foreign investors have had no trouble entering and exiting the Chinese markets.

The last, and perhaps the most important, driver of the bearish sentiment is policy and regulation. Indeed, numerous regulatory shocks from within and outside China have been a constant plague for the markets in recent years.

Internally, not knowing what the authorities are up to with some key policy initiatives – such as “common prosperity” – and the strict implementation of punitive regulations – in tech and education sectors – have led to widespread confusion among foreign investors.

Given the high sensitivity of the Chinese markets to Beijing’s policies, it is understandable that some investors may be losing faith in renminbi assets because of a perceived erosion of policy clarity and credibility.

External developments have added complexity to investing in China too. Growing tensions between the world’s two largest powers have led the US to impose sanctions on Chinese companies, delist ADRs (American depositary receipts), expand the entity lists, and prohibit US investors from holding certain Chinese assets.

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These restrictions have raised the political risks of investing in China, and in turn undermine the attractiveness of Chinese assets to global investors.

Overall, it appears that it is the regulatory and policy uncertainty that has acted as the dominant source of investors’ angst.

Fortunately, senior policymakers in China have started to grasp the issue. After some soothing words to calm investor sentiment, actions have followed with the easing of countercyclical policies, relaxing property market curbs, and Beijing pressing pause on regulatory crackdowns.

The turning of the policy cycle should help to remove a major overhanging risk above the Chinese markets. This, combined with historically cheap valuation, may present an interesting opportunity for long-term investors to start gradually rebuilding China exposure from their large underweight positions.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers