Structural Reforms in China

13 January 2016

Standard Life Investments, the global investment manager, suggests that structural reforms in China will play an important role in determining the trends of global financial markets in 2016. This is one of a series of articles in the January edition of Global Outlook, which also shines a spotlight on emerging markets, examines the global economy into 2016, the outlook for US bond markets and sterling, and drivers of global equities.

Alex Wolf

Alex Wolf, Emerging Markets Economist, Standard Life Investments said:

"In China, we expect policymakers to continue walking a tightrope - balancing enough fiscal and monetary stimulus to prevent a sharper growth collapse, while slowly proceeding with supply side reforms to remove excess capacity. Slowing Chinese demand, which we believe was worse than official data reflected, was one of the largest causes of the emerging market trade and output contraction experienced last year. As such we see some room for cyclical upside, as policy measures take effect.

"However, our longer-term outlook on China has become increasingly negative. Our own view is that GDP growth is closer to 5% than the 6.9% reported by the Chinese authorities. Although we believe policy makers will avoid a hard landing, it is becoming more likely that Chinese leaders will not enact necessary reforms quickly, especially of state owned enterprises (SOE). SOEs are at the heart of China’s problems, and reforms here would deliver the biggest dividends from a growth and rebalancing perspective, but Beijing has been dragging its feet.

"SOE reform plans delivered over recent months were received with optimism, but we believe they failed to address corporate governance issues or the reduction of excess capacity through corporate restructuring and closures.

"Consolidation has been the preferred path, and the government seemed unwilling to sell or reduce state assets in a meaningful way. The plan will lack effectiveness if the focus on addressing loss-making companies and overcapacity is limited to a small number of centrally-owned SOEs, and not the mass of locally-owned SOEs, where most of the overcapacity and inefficiencies lie.

"If China growth does disappoint this could drive continued volatility in global markets. Sluggish growth is priced into markets but a hard landing which impacts on currency, capital flows, commodities and social stability is not. This could result in more aggressive domestic monetary easing, forcing the renminbi lower against the dollar, with adverse implications for global inflation and a blow to emerging markets dependent on robust Chinese demand for manufactured goods and commodities."

Other articles in Global Outlook include:

Five drivers of global business in 2016

Guy Jubb

Jeremy Lawson, Chief Economist, Standard Life Investments names five key drivers which will help determine the global business cycle in 2016: US interest rate policy, Chinese activity, emerging market capital flows, inflation trends and political tensions:

"Whilst in 2015 a mild industrial and trade recession dragged business investment lower - the news is not all bad. Our current forecast is for a small lift in global GDP growth in 2016 towards 3.25% a year. Plunging commodity prices have boosted real income growth in the developed and commodity-importing economies. Combined with improving labour markets this has supported solid consumption growth."

Treasury bond market is swimming upstream

Philip Laing

Philip Laing, Investment Director Government Bonds, Standard Life Investments, suggests that US monetary policy and dollar dynamics are not correctly priced into the US bond market:

"All in all the market is still pricing in a shallower path for interest rates over the medium term than is implied by the Fed’s interest rate projections. The US Treasury market is clearly not expecting an economy that allows the Fed to hike strongly in 2016. Yields in the US and UK continue to price ambitiously towards a limited recovery and extended drivers of low inflation."

US industrial sector doldrums

Mikhail Zverev

Lastly, Mikhail Zverev, Head of Global Equities, Standard Life Investments highlights stock picking opportunities in the domestic US market and the beleaguered US industrials sector:

"All in all the market is still pricing in a shallower path for interest rates over the medium term than is implied by the Fed’s interest rate projections. The US Treasury market is clearly not expecting an economy that allows the Fed to hike strongly in 2016. Yields in the US and UK continue to price ambitiously towards a limited recovery and extended drivers of low inflation."

"Beyond the US, subdued construction activity in some markets has resulted in a benign supply/demand balance in commercial property which has worked to the advantage of property asset owners plus professional real estate management and consultancy services."