Once again, developments in China have reverberated across global equity, currency, and commodity markets and revived fears that surfaced after China’s surprise currency devaluation and stock market crash last summer. 
It was inevitable China’s economy – the world’s second largest – would slow from the double-digit growth attained over previous decades, particularly with the government attempting to transition the economy from one led by manufacturing, investment, and exports to one more driven by domestic consumption and services.
Nevertheless, the slower pace of growth along with mounting concerns whether China’s leaders can effectively manage this transition have sent tremors through global emerging markets several times over the past three years – with fears now impacting developed markets as well.
Performance of indices since June 2015
Source: FE Analytics
However, while the risk of policy mistakes remains high and should be closely monitored, we do not believe a hard landing for China is the most likely outcome.
Policymakers have every incentive to ensure it does not happen; their very existence probably depends on it. Several options, including the use of monetary and fiscal policy, are likely to be used to support growth and smooth the transition.
Even if China grows at 6.3 per cent this year as the IMF forecasts, it is still a very impressive rate in the context of global growth.
Authorities can control currency and debt concerns
The potential for a further unexpected and sharp decline in the renminbi is the key current risk in China, as this could hasten continuing capital outflows and put more pressure on its economy.
Our expectation is China will let the renminbi float within limits against the new basket of currencies, and that would suggest downward pressure this year, but in a fairly controlled fashion.
Our base case is for a managed, gradual devaluation of the renminbi this year and for authorities to re-build confidence in the currency. But it is certainly possible to envisage more disruptive outcomes.
Relative performance of currencies over 2yrs
Source: FE Analytics
In addition, China has experienced a massive buildup of debt since the 2008 financial crisis and a significant rise in non-performing loans (NPLs) in its banking system.
We believe the level of NPLs in China is substantially higher than the 1.5 per cent rate reported.
China’s banking stocks have been trading at valuations indicating a non-performing loan rate of about 6 per cent. If China were to suddenly recognise all of those NPLs, it could prove highly disruptive to the economy and could trigger a financial crisis at some point.
But we think that outcome is extremely unlikely given China’s government control of the banking system and the financial system more broadly.
Asian structural growth story remains robust
Despite the recent turmoil in China’s stock market, we continue to find attractive companies where the long-term benefits should outweigh the near-term risks.
One key area of focus is disruptive technology. Investing in some of China’s high-growth Internet stocks has been very profitable.
We are also finding opportunities in the consumer and service sectors, with Chinese consumers moving up the value-added curve, buying more expensive, higher-quality items. In the services area, health care and logistics offer promising opportunities. We see potential in reform beneficiaries: state-owned enterprises that should benefit from change in government policy over the next few years.
Recent events do not change our longer-term view on China or the rest of Asia. We expect the China market to offer attractive growth opportunities for many years to come.
Also, the structural growth story in Asia remains robust. Economies are growing at healthy levels in a global context, supported by large, often young populations that are moving up the income curve.
As we get more clarity on China’s currency framework, we expect volatility to subside, allowing investors to focus on the more positive features of the China and Asia story once again.
Nick Beecroft is an Asia ex Japan equities specialisty at T. Rowe Price. All the views expressed above are his own and shouldn’t be taken as investment advice.
