UBS: Is China´s stimulus sustainable?

Recent Chinese data suggests growth has stabilized. For some, though, growth worries have been supplanted by debt concerns. Investors are rightly asking whether China’s apparent credit-driven stimulus is sustainable.

22.04.2016 | 11:15 Uhr

Chinese GDP growth steadied to 6.7% in the first quarter, in line with the new 2016 6.5%–7.0% target. Industrial production growth quickened to 5.8% in 1Q from 5.4% at the end of last year. Steel production set records in March. And despite considerable inventory overhang, Chinese new property starts rose 27% y/y in March, and by nearly one-fifth in the first quarter. However, this has come at the cost of higher debt: overall credit rose 16.6% y/y in March to a 21-month high, and adding more debt to sectors already saddled withovercapacity is seemingly at odds with the consum erled growth agenda.

Who wins from stimulusled stability?

Chinese companies – at least some of them – do. In the first two months of the year, industrial profits grew 4.8% y/y, rising for the first time in 19 months. Better earnings contributed to offshore Chinese equities’ 21% rebound from a February nadir. Yet with local stocks still near 20-year low valuation levels, we think further upside is possible. We remain overweight Chinese equities in Asia-ex-Japan asset allocations over a tactical sixmonth horizon.

Emerging markets and commodities have also benefited. We are underweight EM stocks in global portfolios, but note that higher Chinese demand for commodities, goods and services could support an EM growth bounce and lift profits over time.

Sustainable for now, but structural reforms key to growth

We believe China will continue to engage in further policy stimulus this year, potentially raising its non-financial sector debt beyond the 260% of GDP it closed last year with. It can manage this higher debtburden, however, since only 8% of it is external, and the country has a relatively closed capital account, a high and captive savings base, and is a net creditor to the world, with a USD 300bn annual current account surplus.

Medium term, however, stimulus at the current pace, particularly if credit-driven and directed toward sectors with high debt and low productivity, could lead to growing loan losses and weigh on bank balance sheets. Lower profits and slower economic growth could follow, especially if resources are diverted from more productive sectors as a consequence.

China should be able to stabilize its economy even more in coming years, but it must realize that stimulus can only be sustainable if accompanied by structural reforms, and the margins for error are narrowing.

Matthew Carter and Thomas DengGlobal Investment Office

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