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China’s economic prospects and the recent S&P downgrade

Recently S&P, the well-respected rating agency lowered China’s long-term sovereign rating to A+ from AA-, citing that the prolonged period of credit growth imposes risk on the country’s economic growth.

One of the reasons for the increase in debt is justified by the actions taken over the past years by both the Government and the Bank of China in order to maintain growth above 6.5 per cent. However, in my opinion, the downgrade might be debatable if we are to consider other longer-term factors.

It’s a fact that leverage over the past years in China has increased drastically, mainly by real estate corporations, which increased remarkably their debt in order to finance land acquisitions and other development projects.

However, despite the critics that the Chinese property market is in a bubble, over the past months we have continued to experience remarkable increases in property prices, which also were reflected in a surge in profits for the Chinese developers.

Surely, the combined effort by both fiscal and monetary politicians has fueled a construction boom, which also led to a pick-up in demand in industrial metals over the past months (+15 per cent on a year-to-date basis).

For instance, fiscal expenditure in China rose 2.9 percent per cent from a year earlier in August of 2017, slower than a 5.4 percent rise in the prior month, but still considered on the high side. While the cash reserve ratio, the portion of depositors’ balances that a bank must hold in cash, was way back scaled lower to 17 per cent in order to stimulate further lending.

In my view, when digging further into the Chinese economy it is crucial in determining the real factors of economic growth but also most importantly sustainable economic growth.

Personally, I think that demographics and the shift towards the middle-class are key important aspects, which should fuel domestic demand and thus economic growth. For instance, in 2016 the population distribution by age showed that the segment between 0-15 years was at highs of 18 per cent as opposed to that of developed Eurozone economies, which averaged at 12 per cent. This implies that people entering the labour force in China is stronger than that of other countries. 

One other key factor for sustainable growth going forward is the shift China is experiencing in its middle-class. In fact, recent statistics showed that there are roughly 60mn people a year entering the Chinese and Indian middle class, that’s about the population of Italy.

Interestingly enough only 11 per cent of the economic growth is derived from consumerism, as opposed to the 70 per cent in the United States. Thus, this is another clear factor that over the longer-term, domestic demand should grow exponentially, leading also to the possibility of a more self-sustainable economy.  

One of the criticism rating agencies are usually faced with is the lag in timing action. In my view, this is one of my critique towards the recent downgrade. It is a state of fact, that the piling of debt in China has been accumulating over the past years and thus a rating downgrade on such rationale should have been announced earlier.  My point is also based on the acknowledgement by S&P in its report that China’s monetary policy is largely credible and effective. This implies that in case of need monetary politicians will adjust accordingly.

Ultimately, I strongly believe that China has a huge potential over the longer-term primarily triggered by domestic demand. In my view, the over six per cent growth should be sustained going forward. In this regard, holding a Chinese weighting in your portfolio should prove fruitful over the longer-term. Currently, some interesting opportunities which we do hold in our portfolios are in place.     

Disclaimer: This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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