Venturing into the unknown
China is still transitioning from a low-end export-driven model to one that is driven by technology, consumption and services. The government is pursuing a dual-circulation model, which combines import substitution and an expansion of domestic demand. This involves diverting funding to high-end manufacturing, reducing dependence on food and energy imports and slowing the growth of overseas lending and investment.
An additional round of fiscal stimulus could stoke another property bubble, which means it remains unlikely. But overall, there seems to be confidence in the government’s long-term economic policy – something that has historically been well executed. China’s rapid response to Covid-19 is also a source of confidence and while growth is not yet back on track, it is at least in positive territory and came in at 4.9% in Q3.
This dual-circulation policy will have knock-on effects on countries like Australia, which is resource heavy and a major energy exporter to China. Manufacturing businesses are also set to leave China in a drive to offer supply-chain diversification to partners, which means that countries such as India and other ASEAN nations are likely to benefit.
While other regional tech producers like Korea and Japan may have benefited in the short term from US-China trade tensions, their long-term outlook looks more uncertain as China becomes more self-reliant in technology.
Yet China remains on a steep learning curve as it continues to move into developing high value-added products for the global economy. While China has significant market share in home appliances, it critically needs to add talent and resources to move up the technology value chain.
One challenge is the fact that Chinese students cannot currently attend top US schools, while there are also barriers to the country buying American equipment and tech companies as part of a buy/not build strategy. There is currently an executive order in place that stops Americans investing in 31 companies that the US has identified are controlled by the Chinese military. Although this could be revoked, it might be politically difficult to do so.
A greener future
China is also keen to gain ground in the areas of electric vehicles, solar and wind power – but requires equipment and technology to do so. To date, the government has successfully provided direct and indirect subsidies to boost demand and encourage this progress. These include a tax on consumers and minimum standards for energy efficiency, which forces more frequent upgrades of cars and equipment. China currently has low penetration of global markets for alternative energy, so there is an opportunity for it to gain market share in this area.
Coming in from the cold
Joe Biden’s victory in the US presidential election should also have far-reaching implications for China. The country is exposed to change in the US, given that certain parts of the US supply chain will shift to other emerging markets if the US reinstates trade agreements with its traditional allies.
In a similar vein, closer relations between the US and Europe and Japan may alter the outlook for China. Both Japan and Europe are important trading partners: China accounts for 9% of the European Union’s exports and 20% of Japan’s.
Our Asia ex Japan equity team does not currently expect Biden to change the administration’s policy, and its base case is that tariffs and bans will remain in place. However, the team does expect policy to become more predictable and less volatile, while the probability of tail risks – including an escalation of tensions and even a war – should decline. One thing is clear: now the old US-China model has been disrupted, there will be no likely return to the status quo.