Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Gary Greenberg, Head of Hermes Emerging Markets, explains why concerns about slowing Chinese growth are unfounded.
Since the global financial crisis of 2008, the future of emerging market growth has been in doubt. The crisis reset Western growth prospects for good and emerging market policymakers have been looking for a new direction. But which direction, and how?
We’re seeing a wide range of levers being pulled in emerging markets, from profound supply side reforms to deeper political shifts. China is imposing financial discipline on local governments to keep debt levels in check, while in Russia we are seeing intimations of a return to Soviet-era autarky. For us, what is of interest is the changing nature of growth dynamics and how emerging market policy-makers are reacting to a rapidly changing landscape.
The old explosive export-driven growth that was the hallmark of emerging market economies was marked by acute market volatility. This boom-bust cycle has curbed enthusiasm for breakneck expansion with emerging market policymakers. Hence, a number of emerging markets have made the decision to embark on a path of supply side reforms, potentially underwriting a path of sustainable, long-term, steady growth.
Given the centrality of these projects for growth globally, as well as nationally, it is worth taking a brief look at how some of those economies in the forefront are faring, starting with China.
China has seen a deceleration in growth and its stock market has moved into unloved territory. Growth fears have been further magnified by last month’s inflation figures, with September’s 1.6% year-on-year rise the lowest since January 2010.
However, we welcome this moderation in growth, as long as it is accompanied with a move toward more sustainable domestic economy and the Chinese consumer. For China, lower aggregate growth is a precondition for more stable and profitable corporate growth.
Almost a year ago, China embarked on a series of reforms which promised, by giving the market a ‘decisive’ role in the economy, to underwrite sustainable economic growth for the next several decades. Sustainable, market-driven growth will contain a larger consumer and a smaller state-owned enterprise component than currently present, a stronger social safety net, and a higher cost of capital. This is to say, China’s growth over the next decade will certainly slow down.
Unfortunately, the market saw evidence of this slowdown in the first half of the year, even before the implementation of the reforms. Faced with a bursting property bubble, slowing European exports and a banking sector rife with ‘restructured’ loans, the authorities created a fresh mini-stimulus to which the stock market promptly responded. Access to foreign capital was made easier by a planned opening of Chinese A-shares through the Hong Kong market, putting support in place for the domestic equity market.
And the Peoples’ Bank of China instructed banks to keep lending to profitable companies in excess capacity sectors, demanding that banks ‘should not focus only on profits’ and ‘should not irrationally offer higher rates to raise deposits’. So, while we may look forward to a more decisive role for the market in China, the training wheels are still on.
It is difficult to see, let alone forecast, the Chinese economy. Property prices and construction are falling, as is electricity production. Typhoons in June are being blamed by many companies for poor results, and earnings estimates for many consumer staples companies are being trimmed. However, valuations look sensible, at 9.0x 2015 estimates and 1.4x 2014 book value, in light of 10% earnings growth next year.
Emerging market economies are at the crossroads. But there are signposts to growth, if you can decipher them. The old export-driven model is dead. A new one is being born, where capital discipline is king. The story for emerging markets is improving, and changing from one of trading to one of long-term investment. If the economic backdrop remains benign, major emerging market economies such as China, Mexico, Brazil and India will have room to enact reforms which transform their economies from tigers into slower but steady elephants.
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