Fixed Income: China's Economic Dilemma

The current economic weakening does not change our view that the Chinese currency is undervalued and will perform very well over the medium-term as the authorities have plenty of scope to get the economy back on track.

The Chinese bond market is one of the biggest in the world and the Chinese economy, many forecast, will overtake the U.S. as the largest in a matter of years (China is already the largest in PPP terms). However, recently we have all seen the authorities’ clampdown on the tech learning sector and most recently the property sector hurt economic momentum.

Last Friday we had the release of the PBoC’s Monetary Policy Implementation Report, a quarterly release, which identified pressures created by shrinking demand, supply shocks and weakening expectations. Unsurprising, it never mentioned the somewhat clumsy intervention by the authorities in the two aforementioned sectors, tech learning and property. 

However, it does reflect an outlook which shows that the PBoC has only just begun to ease monetary policy, and that further cuts in the lending facility, already cut 10bp in January, and the reserve requirement ratio is to be expected. It also placed a high priority on “maintaining reasonable credit expansion”, adding the need to, “guide financial institutions to forcefully expand credit”. Our read on this is that they will permit a rise in macroeconomic leverage as the report noted China’s debt to GDP ratio did not rise substantially in the early days of the pandemic and has fallen for the last five months. We therefore expect higher leverage as they turn up the monetary support.

We do have some exposure to the Chinese bond market through the higher rated companies such as Sinopec, but in US dollar denominated assets. We also do take positions in the Chinese currency where permitted and of course have our Renminbi Bond Fund which has 100% exposure to the currency through an overlay; the carry on the offshore renminbi is ~2%. The current economic weakening does not change our view that the currency is undervalued and will perform very well over the medium-term as the authorities have plenty of scope to get the economy back on track.

Freddie Coldham
Fund Manager, Fixed Income