Policy will focus on industrial upgrading and import substitution so that the country is better able to withstand external market volatility and can attract global investors seeking to diversify their sources of returns. This means that demand for domestic brands in technological and financial innovation, industrial consolidation, bio-technology and consumer upgrading should support asset prices in the midst of a prolonged Sino-US tech war.
Our base-case forecast is for 6.6% GDP growth in 2021 (see exhibit 1). This is lower than consensus because we expect Beijing’s resolve to restart its deleveraging and structural reform measures to have a significant impact and become a drag on GDP growth. It is worth noting that so far, the recovery in demand has been sluggish, leaving the production side of the economy as the key driver of growth in 2021.
The deleveraging resolve
Successful vaccine deployment should boost GDP growth, but the positive impact may not be as dramatic as in the developed world because China’s economic normalisation is already well advanced, leaving less room for further gains. Beijing's confidence in the recovery's staying power is encouraging the government to restart deleveraging, albeit cautiously.
The recent rise in bankruptcies (including the bank failures in 2019) and bond defaults (notably some local state-owned enterprises (SOE) defaults this year) show that Beijing prioritised deleveraging and retreated from the implicit guarantee policy as soon as the threat to GDP growth faded. Of course, there is a risk of being overly confident in the system’s resilience and COVID-19 could return, but Beijing is taking its chances for good reasons.
China’s resolve to cut debt and reduce financial risk can be seen in Beijing’s tightening control of fintech platforms and the demise of peer-to-peer lending. Data show that in November, the number of P2P platforms had dwindled to zero from a peak of almost 4 000 in late 2016 and early 2017. Beijing’s clampdown on the P2P players did not stop in spite of adverse economic conditions since 2018.
The country's financial sector regulator has highlighted the need to prevent moral hazard in financial institutions (including fintech platforms). He indicated the government would not intervene as long as institutions could resolve risk positions and that there would be strict standards for using public funds for bail-outs. All this suggests shareholders might have to bear the brunt of any losses by financial institutions.
Policy stance in 2021
While more defaults are expected, Beijing is seeking to deleverage the system by forcing bad companies (including local SOEs) to make room for the new growth sectors. This creative destruction process should be positive in the medium term. The macroeconomic impact should be manageable, though short-term market sentiment could suffer as investors are uncertain about when the authorities would move to a bailout.
Since recent defaults have not affected the economic recovery, the central bank is sticking with its neutral policy stance, with its next move expected to be data-dependent.
The credit growth cycle appears to have peaked with the credit impulse topping out. However, with deflationary pressures dominating in China (see exhibit 2) and Beijing’s debt-reduction initiatives adding to those, there are no grounds for monetary tightening.
The central bank’s top job now is to ensure sufficient liquidity to sustain the economic recovery and facilitate Beijing’s financial clean-up efforts without causing a credit default blowout. Government yields can be expected to range between 3.0% and 3.5% in 2021 under these conditions.
Post-Trump international environment
Given that the incoming Biden administration supports multilateralism, opposes unilateral tariff hikes, and seeks opportunities for dialogue instead of conflict, the probability for tariff-war escalation in 2021 should diminish. This is positive for trade between the two countries and the renminbi exchange rate as long as Beijing fulfils its commitment to the phase-one trade deal and offers favourable terms to facilitate any new Sino-US trade talks.
Biden’s stance on Taiwan and the South China Sea is to maintain the status quo, while re-entering the Iran nuclear deal will be an area of cooperation with China. Such policy shifts should lower currency risk and support renminbi sentiment. However, Biden is unlikely to reverse the tech export controls. He might be more flexible in handling the tech national security issues. Some companies on both sides may get a reprieve.
Global portfolios tilting east
We see long-term investment opportunities in the tech-based domestic-driven growth areas. COVID-19 has sped up China’s transformation by reinforcing the forces of de-globalisation and economic decoupling from the US.
Given its long-term policy and growth aspirations to be a global economic power, Chinese assets should become an asset class in its own right rather than part of an emerging market allocation. International benchmark providers have already been increasing the share of Chinese assets in their stock and bond indices.
 Bloomberg consensus puts China’s 2021 GDP growth at 8.2% YoY and CPI inflation at 1.8% YoY (as of 7 December 2020).
 See “Chi on China: China’s Bank Failures – a Turning for The System”, 28 August 2019.
 See “Chi Time: China’s P2P Crisis – Financial Innovation Backfires”, 27 August 2018.
 See https://www.thepaper.cn/newsDetail_forward_10215863 (in Chinese), https://www.finextra.com/newsarticle/37110/china-hints-more-fintech-regulation-to-come, and https://www.caixinglobal.com/2020-12-08/fintech-giants-could-pose-new-systemic-risks-warns-banking-watchdog-chief-101637128.html
 See “Chi Flash: China’s SOE Defaults, What’s Happening?” 26 November 2020.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
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