Headlines can be misleading, as proved by last week’s IMF report on China. “IMF warns China over dangerous levels of debt’’ reported the FT, quoting the IMF statement that “international experience suggests that China’s current credit trajectory is dangerous with increasing risks of a disruptive adjustment”. The Guardian also seemed concerned about the “dangerous” growth of debt, which “risks sharp slowdown or financial crisis”. Equally readers of the Telegraph now know that “China’s debt boom could lead to a financial crisis” with “an extraordinary debt bubble”.
While none of these reports were factually inaccurate, a glance at the IMF report can give a slightly less bearish feel. The IMF’s own summary starts like this: “Policy support, strengthening external demand, and supply-side reforms have helped maintain strong growth… Regulators have recently focused on addressing financial sector risks…”. To me this sounds relatively positive. And it continues: “China has the potential to sustain strong growth…but…requires accelerating reforms”.
Of the commentators quoted above, it was only the Telegraph that mentioned any reasons why China might be a slightly different beast to the debt-ridden developed world in the run-up to 2007’s global financial crisis. They pointed out that “any credit crunch could be limited by China’s current account, low level of external debts and low loan-to-deposit ratio”.
And this for us as investors is probably more to the point. China has grown its debt far too fast recently, but the structure is odd in that it is largely loans from government controlled entities, to government controlled entities. This means that reorganising the debt burden should be easier than in a less centrally controlled environment. It does not avoid having multiple vested interests which will strive to protect their positions. Nor does it mean that you want, as an investor, to be gambling on which side of those battles will dominate. It does, however, mean that an imminent financial crisis is pretty unlikely.
And what this in turn means is that as long as we are right and there is not a financial crisis, large parts of the Chinese equity market remain a great source of growth and income at reasonable valuations. This is where we have invested 37% of the Liontrust Asia Income Fund, in areas where ongoing domestic demand or government-supported investment can lead to longer-term growth. Not in areas where moribund companies were kept alive for employment rather than profit.
As China slowly rebalances its economy, much of our job is likely to be remain avoiding the areas which are negatively affected in the process, and monitoring for ongoing improvements. Without these then at best growth will continue to deteriorate while risks rise, but at the moment this is not happening. Instead regulators are taking bolder decisions than most would have expected to address the issues – especially with debt – that need to be addressed. The Chinese government appears to have enough understanding of the problems, with enough assets on their balance sheet to avoid this becoming a systemic risk, at least for the near-term and hopefully beyond.
Maybe one of the important lessons from the global financial crisis was that we should never underestimate a central bank’s ability to protect its financial system, and in China the Communist Party will surely fight hard before becoming embroiled in a home-grown financial crisis. That should provide a benign backdrop to seek out selective opportunities for investors.
Mark Williams is head of Asia income at Liontrust