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China puts on weight

John Redwood, Charles Stanley's Chief Global Economist, looks at increases in China’s weighting in emerging markets indices and its current domestic and external issues.

China puts on weight

by
John Redwood

in Features

05.03.2019

MSCI have decided they will increase the number and importance of Chines shares in their emerging markets Index. Currently China is about one third of the total value of shares in that index. This is almost entirely made up of “H” shares, or the shares that are traded outside the Chinese mainland markets through Hong Kong. The domestically-traded shares, or “A” shares, are just 0.8% of the total. Were they to include all the “A” shares, China would rush up to 42% of the total emerging market portfolio. Instead, MSCI will proceed cautiously and moderately slowly with its China “A” build-up.

In the past “A” shares were excluded on the grounds that investors outside China could not buy them. Now the Chinese are relaxing their rules a little and their domestic share market is becoming more liquid, so the West will gradually lift the restrictions on index representation. MSCI, in their latest statement, draws attention to the reducing number of times there are temporary bans or suspensions on trading any given share as part of the case for increasing the holding. The extent of the China weighting in the index is a reminder of just how large the world’s second economy has become already, and how it is moving gradually to dominate the emerging market universe. The second and third placed countries represented in the Index, South Korea and Taiwan, are so much smaller as economies and as share markets than the giant next door. South Korea is currently 13.5% of the Index and Taiwan 11%.

Chinese shares suffered badly in the summer of 2015 when the authorities lost control of the markets both on the way up to a spiked top, and on the rapid way down. They allowed too much local speculation on borrowed money and then introduced restrictions to curb the excesses. Large numbers of shares were unable to trade for periods of time, given the large price movements and the rules over volatility. The share market performed badly for the next two and a half years. Since the beginning of 2019 it has put in a good performance, on the basis that the government and Central Bank will need to reflate a bit. Shares became very good value, and even after the recent rise are still on 12 times earnings.

The Chinese government is meeting this week to review progress and to put measures to the NPC or people’s legislature. This body has a tradition of passing whatever legislation is put before it, but the authorities are keen to avoid criticism and adverse commentary that could still spill out from such an event. The Prime Minister has explained that they expect Chinese growth to fall a little to the 6% to 6.5% range in 2019. There will be a few more tax cuts, and they are working on a range of credit measures to provide capital to new and growing businesses. Meanwhile, the central bank has recently held a conference on financial stability and has repeated tough messages about the need to avoid financial risks getting out of control. They are trying to walk a difficult tightrope between, on the one hand, cutting excesses in the banking, asset management and wider financial sector and, on the other, allowing sufficient new credit to permit hitting the growth target. The compromise emerging seems to rely more on fiscal measures with increased spending and tax cuts than on deliberate credit inflation, with lower growth targets and reduced ambitions over employment.

The official language coming out of the meeting blames the external situation and the Trump trade war for the slowdown in China. It reinforces the likelihood of a trade deal with the US and reminds us that China is still very dependent on the big exporting industries built up in their period of sustained fast growth in the previous decade. We turned bullish on China at the turn of the year, expecting reflation and a trade deal. There may be a bit more good news to come out, but there could be a continuing discount on Chinese shares to allow for the weaknesses of the governance model and the tensions between financial stability policy and growth policy.

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