Slowing expectations of growth in China have sent the country’s stock markets into another retreat today after a week of falls, despite a second rate cut in less than six months by the People's Bank of China.
Premier Li Keqiang told the Chinese parliament that he is expecting the country’s economic momentum to slow this year to the lowest level of growth for 25 years. This follows recent rate cuts by the Chinese central bank this week and in November 2014 aimed at stimulating the economy.
China stocks took a hit after the Beijing government downgraded its expectation for economic growth from 7.5 per cent in 2014 to 7 per cent this year.
Once the go-to emerging market story, thanks to its rapid economic growth over the last decade, sentiment has become more mixed for the potential of decent returns from China with investors and managers highlighting more and greater risk of late.
According to FE Analytics, the MSCI China index has gained 338.02 per cent over the past decade while the average fund in the IA China/Greater China sector is up 213.92 per cent.
Performance of index and sector over 10yrs
Source: FE Analytics
However, positive sentiment has appeared to shift toward the only other country undergoing such a rapid large transformation: India, which has seen a material gain in its stock markets over the past year.
Madden says the announcement from Beijing is worrying for those expecting similarly high returns over the next decade but that markets have already been expecting such a downgrade.
“It was no surprise and 7 per cent isn’t exactly a bad a rate of growth – but it is relatively slow for China. I don’t see any sort of major crash coming out of China but, in the medium term at least, it is fair to say its best days are behind it,” he said.
“Also, of major concern is the creeping bad debt of Chinese banks. It is not unlike the cause of the eurozone debt crisis, which was about the cheap and available credit. There has been a large increase in bad debt being racked up in the Beijing-controlled banks.”
However, he says while investors should expect lower returns they can also expect lower volatility.
While the market is up more than 30 per cent over the past year, the index has started to fall over the past month, albeit marginally.
Performance of index over 1yr
Source: FE Analytics
Mark Tinker, head of AXA Framlington Asia, believes investors are overly cognisant of risks to the Chinese market, without knowing about a host of tail winds.
“Few if any know anything about the Hong Kong Shanghai Stock Connect, let alone the upcoming Shenzhen Connect, the mutual recognition system for mutual funds, the new Silk Road infrastructure spending, the free trade zones or the ongoing land and labour reforms. This is not to be wild-eyed and bullish, rather to aim to focus on upcoming winners of reform under the new model not just the losers from the old model,” he said.
Kamel Mellahi, professor at the Warwick Business School, says that even with a downgrade in expectations of China’s growth rate, 7 per cent is not an easy target to hit although he believes it is attainable.
“The Chinese economy is fighting against strong headwinds from low domestic consumption and mounting deflationary pressures to intolerable levels of pollution,” he said.
“That said, I don’t think these deep seated challenges are going to bring the world's second-biggest economy to its knees. The economy is losing speed, but at the same time it is becoming more balanced and more sustainable. Plus, I think the Chinese government has enough ammunition to pull the economy from slipping into a deceleration cycle.”
"Internationally, slower economic growth will hurt China’s major trading partners – the US and the European Union. We have seen imports from the US and the European Union falling for a few months now and one expects this trend to continue well into 2015.”
Mellahi says job creation numbers have a bigger effect on economic sentiment for Chinese citizens than hitting a growth target and this will be a key driver to rebalance the economy away from exports to consumption.
“As long as enough jobs are created to absorb the large workforce entering the labour market, I do not see the slowing down of the economy spilling over into major socio-political issues such as large social unrest,” Madden said.
“Most of the unrest in China is actually triggered by labour-related issues, along with pollution, and land grab by local politicians. The challenge for the Chinese government is to ensure that enough jobs are created despite the economic slowdown.”
"The speed of deceleration will depend in large part on how consumers, the key drivers of economic growth, respond to further interest cuts, and the pace of implementation of the array of planned reforms.”
However, he adds that the big question is how long and how successfully Beijing can steer the country from its current model to a new “balanced, less polluting, more innovative, and local-consumption driven” model.
“One thing is for certain: far reaching reforms need to take place for this to happen. In particular regulations and barriers that stifle entrepreneurship and innovation must be dismantled and eliminated."