Andy Rothman, investment strategist at US-based Matthews Asia, discusses whether the consensus view of the Chinese economy may be unduly gloomy.

Recent data signals that a gradual, consumer-led recovery is underway, and the two main, short-term obstacles to a return to pre-pandemic growth levels are likely to recede in the coming quarters, Andy Rothman at Matthews Asia, an investment specialist, said this week.

He asks, rhetorically: "It’s in vogue to be pessimistic about China’s economy, but is the consensus view too negative?"

Rothman highlighted that most of the developed world moved on from Covid-19 two years ago, while the last wave of Covid-19 cases and deaths in China only ended in January 2023, restraining household sentiment and spending. With each passing month, Rothman thinks that Chinese consumers should regain more confidence, supported by high savings and strong income growth. The government also took the step in July of voicing enthusiastic support for the private sector, including platform companies, in an effort to restore entrepreneurs’ animal spirits, which have been weak for two years, he said.

The resilience of Chinese consumers and entrepreneurs, as well as the "pragmatism" of the country’s policymakers, have often been underestimated, and that is likely the case again today, he added in a note about the country.

One of the fundamental elements of Rothman's thinking about China, he said, is that the leadership of the Chinese Communist Party (CCP), including under Xi Jinping, has been successful when its economic policies have been pragmatic. They have made plenty of mistakes but have course-corrected to a more pragmatic path.

The second element is that Chinese families and entrepreneurs are resilient, he continued. The last several quarters have been rough, but Xi’s 10-year, economic track record as Party chief has been "pretty good." Between 2012 and 2022, China recorded average annual real income growth of 6.2 per cent, compared with 1.4 per cent in the US and 1 per cent in the UK, Rothman added.

The Matthews Asia commentary comes at a time when there have been some concerns about President Xi's crackdown two years ago on sectors such as tech and private education, and the impact that the tougher regime will have on trade flows and entrepreneurship. Even so, there have been other voices of cautious optimism. In late June, for example, HSBC Asset Management said it thought Chinese equities have scope to perform this year given the economic reopening and positive earnings momentum, saying that the diversification benefits of Chinese equities shouldn’t be underestimated.

So far this year, Chinese equities have lagged. The MSCI China Index shows total returns of 4 per cent (capital growth and reinvested dividends). By contrast, the MSCI World Index of developed countries shares shows returns of 10.22 per cent. 

Back to the future
There are "green shoots" in the services sector, which is the largest part of the economy and the biggest employer. In the first half of 2023, per capita spending on services rose almost 13 per cent year-over-year (YoY), Rothman said. Domestic tourism revenue during the first six months of the year, for example, rose by 96 per cent year-on-year. This was fuelled by strong income growth: an increase of 8 per cent YoY in real terms in the second quarter, up from 4 per cent in the first quarter and the fastest pace since the third quarter of 2021. One of the brightest data points is that in each of the last two quarters, household consumption increased at a faster pace than the growth rate of income, signalling an initial recovery in consumer confidence, he continued.  

Overall, the economy is sluggish but household consumption seems to be gaining momentum in the last couple of months, especially when compared with the same periods in pre-Covid 2019. 

Solving for short-term problems
The CCP Central Committee (the senior Party leaders) and the State Council (the top arm of the government) also recently issued a joint statement on “promoting the development and growth of the private economy," Rothman said. The document is intended to “boost confidence in the outlook for the private economy.” It says Xi’s administration will support private firm research into “cutting-edge technology” and “support platform companies to excel in creating jobs.” The document also calls for “an atmosphere that encourages innovation and tolerates failure” and “enhances the sense of honour and social value of entrepreneurs.”

That was followed a few days later by a meeting of the top 24 members of the Central Committee, who reiterated support for entrepreneurs and platform companies. These announcements from Party leaders followed other vows of support in July for private firms, especially the platform companies, which, account for about one-quarter of urban employment. Rothman thinks that Xi’s priority is restoring economic growth, and private companies, including the platforms, which are China’s biggest employers, so he expects him to follow up with concrete actions. If investors are patient, they are likely to see more evidence of a gradual, consumer-led economic recovery in the coming quarters, as the Covid trauma recedes and the government follows the leadership’s directive to get out of the way of business, allowing animal spirits to re-emerge, he said.

A return in confidence will be supported by continued accommodative monetary policy and high savings, he said. Family bank balances have increased 63 per cent from the start of 2020, as Chinese households were in savings mode during China's anti-Covid measures. The net increase in household bank accounts is equal to $7.1 trillion, which is greater than the GDP of Japan in 2022, and equal to 125 per cent of China’s 2019 retail sales, he said. This is significant fuel for a continuing consumer spending rebound, as well as a recovery in mainland equities, where domestic investors hold about 95 per cent of the market.

Rothman thinks that although China’s debt problem is serious, the risk of a hard landing or banking crisis is low. Cleaning up China’s debt problem will be expensive, and does limit the government’s options for fiscal stimulus, but will not likely lead to a dramatic hard landing or banking crisis. Industrial policies have also resulted in China becoming the world’s largest producer, consumer and exporter of electric vehicles, and accounting for two-thirds of global EV battery production, as well as about 80 per cent of global solar panel production, he said. China is on track to surpass Japan as the world’s largest auto exporter in 2023, after edging out Germany last year, he added.

Meanwhile, he believes that the political relationship between Washington and Beijing is likely to remain strained, but a crisis is unlikely, especially after the Biden administration has recalibrated its approach to China in recent months. Although China is sending less of its goods to the US, it has gained market share elsewhere. China’s share of global exports in the first quarter of 2023 was 14 per cent, compared with 12.8 per cent in 2017, before the Trump tariffs. More importantly, domestic demand is the primary growth engine in China, he said. As a result of these factors, he believes that the consensus view may be too negative.