April 25, 2019

Matthews Asia has been investing in Asia since 1991 and we draw on our experience to identify investment opportunities that stand to benefit from the development of markets throughout the region.

The World’s Cheapest Stimulus

April 17, 2019

With just a modest boost to credit, the Chinese government succeeded in strengthening investor sentiment and stabilizing real economic activity during the first quarter of the year. The growth rates of income, retail sales and industrial production were stronger than in the fourth quarter of last year, without a dramatic stimulus. The central bank has signaled that it is comfortable with growth prospects for the coming quarters and wary of unnecessarily raising the national debt burden, so any additional stimulus will likely be even more modest.

In my view, the biggest weakness in China last year was poor sentiment among the country's entrepreneurs and investors, despite reasonably healthy macro activity and strong corporate earnings growth. This provided the government with an opportunity to take several inexpensive steps to boost sentiment.

As expected, the state-controlled banking system increased credit flow during the first quarter, but—also as expected—the increase was modest. The growth rate of outstanding augmented total social finance (TSF), the most comprehensive metric for credit in the economy, accelerated to 11.3% year-over-year (YoY) in March, up from 10.8% in February and the first month over 11% growth since September. But, to put this into context, the 11.3% pace in March was slower than the 12.6% pace in March 2018; the 14.6% in March 2017 and 16.6% in March 2016.

Another way to illustrate the modest scope of the credit stimulus is to look at the gap between the growth rate of augmented TSF and the growth rate of nominal GDP. In the first quarter of 2019, the gap between the growth rate of credit and of nominal GDP was 3.5 percentage points (pps), roughly the same as the 2.3 percentage point gap in 1Q18, and significantly smaller than the 9.7 pps gap in 1Q16. To put this into further context, in 2009, as Beijing was responding to the Global Financial Crisis, the gap was 26.8 pps.

It is also worth noting that the government has not abandoned its financial sector de-risking campaign. Off-balance sheet, or shadow credit, declined 10.3% YoY in March, compared to increases of 5.5% in March 2018 and 11.5% in March 2017.

Beijing also refrained from turning on its traditional public infrastructure stimulus taps. Infrastructure investment rose only 4.4% in the first quarter, compared to 5% in 4Q18 and 13% in 1Q18.

In addition to the modest boost to credit, the other steps taken by the Chinese government to improve sentiment were:

Intensive and apparently flexible negotiations with the Trump administration, leading to expectations that the tariff dispute will not escalate into a trade war. Treasury Secretary Steven Mnuchin recently said, “We're hopeful that we're getting close to the final round of concluding issues.”
This dispelled the key reason for pessimism, as Chinese investors had told me they were concerned about far more than just a disruption of shipments to what was China's top export market. They worried that Trump might escalate the conflict beyond tariffs, limiting the ability of Chinese to study in the U.S., or banning Chinese imports of American semiconductors, which are a foundation of China's tech sector. The negative consequences of a possible Cold War-style relationship between the world's two largest economies weighted heavily on domestic sentiment last year.

Xi Jinping resumed his rhetorical and policy support for China's private firms, which account for most employment and all net new job creation in China. During the first three quarters of last year, for reasons that remain unclear, Xi had voiced strong support for state-owned enterprises (SOEs), while expressing little love for entrepreneurs, leaving them apprehensive about the future. During the last several months, however, Xi has gone out of his way to embrace entrepreneurs and to instruct banks to boost lending to smaller enterprises.

Value-added taxes (VAT) and personal income taxes were cut, delivering a boost to consumer and producer sentiment. These steps are part of a long-running effort to reduce taxes and fees, and are not a short-term stimulus, but the impact on sentiment was material. (Removing 84 million workers from the personal tax rolls never hurts consumer sentiment.)

The most striking impact of all of these steps was that during the first quarter, the Shanghai Composite Index (A-shares) rose 24%, and as of April 16 was up 30% year-to-date, almost erasing the 25% full-year decline in 2018.

Improved sentiment also delivered a modest boost to economic activity. Most first-quarter macro numbers were stronger than expected: up from the fourth quarter, although still weaker than during 1Q18.

One of the brightest spots was strong income growth, supporting the largest part of the Chinese economy, consumption and services. The cut to personal income taxes led the real (inflation-adjusted) growth rate of per capita disposable income to reaccelerate in the first quarter, rising 6.8%, up from 6.1% in 4Q18 and 6.6% a year earlier. This drove real retail sales up 6.9% YoY in the first quarter, up from 6.0% in 4Q18 but down from 8.1% in 1Q18.

The consumption story has stabilized but has not fully recovered: the nominal growth rate of household consumption, based on a quarterly survey, slowed to 7.3% in the first quarter, down from 8% in 4Q18 and 7.6% a year ago.

Manufacturing also stabilized, with industrial value-added rising 6.5% in the first quarter, up from 5.7% in 4Q18 but down from 6.8% in 1Q18.

The most disappointing data point signaled that privately owned firms remained cautious in the first quarter, as their investment rose by only 6.4%, down from 8.7% in 4Q18 and 8.9% a year ago. I will be watching closely to see if the confidence of China's entrepreneurs returns later this year.

In the coming quarters, I expect to see additional modest improvement in macroeconomic conditions, due in part to stabilizing sentiment and a weaker base. I also expect that growth rates for corporate earnings will remain healthy, although a bit slower than last year. The biggest risk to these expectations would be the failure of Trump and Xi to reach an agreement to avoid a trade war. Given that both leaders seem flexible and keen to strike a deal, I think that risk is low. Trump seems to believe that resolving this problem is important to his re-election prospects, and Xi wants to avoid a conflict that could escalate into a trade war, jeopardizing China's long-term economic development.

While a Trump—Xi deal is likely on the horizon, it will not resolve the longer-term challenges in bilateral relations. But, taking a trade war off the table is a prerequisite for starting to address those challenges.

Regards,
Andy Rothman
Investment Strategist
Matthews Asia

Sources: Mathews Asia, CEIC, Ministry of Finance

a

Investor sentiment recovered

and real activity stabilized in

the first quarter, with only

a modest credit boost.

a

I expect to see further

improvement in the

coming quarters, without

significant stimulus.

a

The biggest risk to these

expectations would be the

failure of Trump and Xi to

reach an agreement to avoid

a trade war. Given that

both leaders seem flexible

and keen to strike a deal,

I think that risk is low.

ANDY ROTHMAN

lived and worked

in China for more than 20 years,

analyzing the country’s economic

and political environment, before

joining Matthews Asia in 2014.

As Investment Strategist, he has

a leading role in shaping and

presenting the firm’s thoughts on

how China should be viewed at the

country, regional and global level.

THE WORLD’S CHEAPEST STIMULUS

With just a modest boost to credit, the Chinese government succeeded in

strengthening investor sentiment and stabilizing real economic activity

during the first quarter of the year. The growth rates of income, retail sales

and industrial production were stronger than in the fourth quarter of last

year, without a dramatic stimulus. The central bank has signaled that it is

comfortable with growth prospects for the coming quarters and wary of

unnecessarily raising the national debt burden, so any additional stimulus will

likely be even more modest.

In my view, the biggest weakness in China last year was poor sentiment among

the country’s entrepreneurs and investors, despite reasonably healthy macro

activity and strong corporate earnings growth. This provided the government

with an opportunity to take several inexpensive steps to boost sentiment.

As expected, the state-controlled banking system increased credit flow

during the first quarter, but—also as expected—the increase was modest. The

growth rate of outstanding augmented total social finance (TSF), the most

comprehensive metric for credit in the economy, accelerated to 11.3% year-

over-year (YoY) in March, up from 10.8% in February and the first month over

11% growth since September. But, to put this into context, the 11.3% pace in

March was slower than the 12.6% pace in March 2018; the 14.6% in March

2017 and 16.6% in March 2016.

Another way to illustrate the modest scope of the credit stimulus is to look

at the gap between the growth rate of augmented TSF and the growth rate of

nominal GDP. In the first quarter of 2019, the gap between the growth rate of

credit and of nominal GDP was 3.5 percentage points (pps), roughly the same

as the 2.3 pps gap in 1Q18, and significantly smaller than the 9.7 pps gap in

1Q16. To put this into further context, in 2009, as Beijing was responding to the

Global Financial Crisis, the gap was 26.8 pps.

It is also worth noting that the government has not abandoned its financial

sector de-risking campaign. Off-balance sheet, or shadow credit,

declined

10.3%

YoY in March, compared to

increases

of 5.5% in March 2018 and 11.5% in

March 2017.

Beijing also refrained from turning on its traditional public infrastructure

stimulus taps. Infrastructure investment rose only 4.4% in the first quarter,

compared to 5% in 4Q18 and 13% in 1Q18.

In addition to the modest boost to credit, the other steps taken by the Chinese

government to improve sentiment were:

Intensive and apparently flexible negotiations with the

Trump administration, leading to expectations that the tariff

dispute will not escalate into a trade war.

Treasury Secretary

Steven Mnuchin recently said, “We’re hopeful that we’re getting close to

the final round of concluding issues.”

Sinology

by Andy Rothman

April 17, 2019

This dispelled the key reason for pessimism, as Chinese investors had

told me they were concerned about far more than just a disruption of

shipments to what was China’s top export market. They worried that

Trump might escalate the conflict beyond tariffs, limiting the ability of

Chinese to study in the U.S., or banning Chinese imports of American

semiconductors, which are a foundation of China’s tech sector. The

negative consequences of a possible Cold War-style relationship

between the world’s two largest economies weighted heavily on

domestic sentiment last year.

Xi Jinping resumed his rhetorical and policy support for

China’s private firms, which account for most employment

and all net new job creation in China.

During the first three

quarters of last year, for reasons that remain unclear, Xi had voiced

strong support for state-owned enterprises (SOEs), while expressing little

love for entrepreneurs, leaving them apprehensive about the future.

During the last several months, however, Xi has gone out of his way to

embrace entrepreneurs and to instruct banks to boost lending to smaller

enterprises.

Value-added taxes (VAT) and personal income taxes were cut,

delivering a boost to consumer and producer sentiment.

These

steps are part of a long-running effort to reduce taxes and fees, and are

not a short-term stimulus, but the impact on sentiment was material.

(Removing 84 million workers from the personal tax rolls never hurts

consumer sentiment.)

The most striking impact of all of these steps was that during the first quarter,

the Shanghai Composite Index (A-shares) rose 24%, and as of April 16 was up

30% year-to-date, almost erasing the 25% full-year decline in 2018.

Improved sentiment also delivered a modest boost to economic activity. Most

first-quarter macro numbers were stronger than expected: up from the fourth

quarter, although still weaker than during 1Q18.

One of the brightest spots was strong income growth, supporting the largest

part of the Chinese economy, consumption and services. The cut to personal

income taxes led the real (inflation-adjusted) growth rate of per capita

disposable income to reaccelerate in the first quarter, rising 6.8%, up from 6.1%

in 4Q18 and 6.6% a year earlier. This drove real retail sales up 6.9% YoY in the

first quarter, up from 6.0% in 4Q18 but down from 8.1% in 1Q18.

The consumption story has stabilized but has not fully recovered: the nominal

growth rate of household consumption, based on a quarterly survey, slowed to

7.3% in the first quarter, down from 8% in 4Q18 and 7.6% a year ago.

Manufacturing also stabilized, with industrial value-added rising 6.5% in the

first quarter, up from 5.7% in 4Q18 but down from 6.8% in 1Q18.

The most disappointing data point signaled that privately owned firms

remained cautious in the first quarter, as their investment rose by only 6.4%,

down from 8.7% in 4Q18 and 8.9% a year ago. I will be watching closely to see

if the confidence of China’s entrepreneurs returns later this year.

In the coming quarters, I expect to see additional modest improvement in

macroeconomic conditions, due in part to stabilizing sentiment and a weaker

base. I also expect that growth rates for corporate earnings will remain healthy,

although a bit slower than last year. The biggest risk to these expectations

would be the failure of Trump and Xi to reach an agreement to avoid a trade

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war. Given that both leaders seem flexible and keen to strike a deal, I think that

risk is low. Trump seems to believe that resolving this problem is important to

his re-election prospects, and Xi wants to avoid a conflict that could escalate

into a trade war, jeopardizing China’s long-term economic development.

While a Trump–Xi deal is likely on the horizon, it will not resolve the longer-

term challenges in bilateral relations. But, taking a trade war off the table is a

prerequisite for starting to address those challenges.

Regards,

Andy Rothman

Investment Strategist

Matthews Asia

Sources: Matthews Asia, CEIC, Ministry of Finance

Disclaimers