China syndrome: slow growth brings back Beijing's pragmatism

With the Chinese economy projected to grow just 3.5% this year - down from a previous forecast of 3.9%, according to Bloomberg's latest quarterly review - regional investors and foreign businesses in China are increasingly concerned about the risk of prolonged recession in the world’s largest economies.

Recent policy easing might support property sales, but Moody's does not expect a strong recovery over the next 12 months.

The residential property market will continue to drop amid prolonged weak homebuyer sentiment, it said. “Any recovery will depend on the extent and effectiveness of more supportive measures from the government.”

INFLATIONARY PRESSURES

The challenges posed by global inflation, the ongoing pandemic and Russia's war in Ukraine, are proving progressively harder for monetary policymakers to address, since the main policy tool typically used to combat inflation – interest rate rises – impacts the demand side of the inflation equation and does little to address supply bottlenecks.

Institutional investors are focusing more on the frantic attempts by global central banks to avoid recession.

Melbourne-based UniSuper’s lead economist and investment manager, David Colosimo, said if there is one issue that is causing risk sentiment to take another downturn, it is the US Federal Reserve.

Speaking in a podcast last week, Colosimo said that earlier in the year there was a sense that the US could achieve a soft landing, rather than a recession, without too much tightening from the Fed.

But over the last month we have seen a number of Fed officials pushing back. This culminated in a speech last week by Fed chairman Jerome Powell at Jackson Hole.

Powell’s view was that inflation, interest rates and recession concerns continue to persist and that the Fed has put global financial markets on notice that it will act aggressively to manage inflation. That means higher interest rates and the possibility of slowing global economic growth.

“Remarkably, he also said that any pain involved was an acceptable price to pay to get inflation back to target,” said Colosimo.

“He does seem to be acknowledging that a recession is quite a likely outcome and that’s a global theme. They’ve already delivered a couple of oversized increases to rates of 0.75%. Given this, it may soon be time to slow that pace of hiking.”

The next Fed statement is expected on September 21.

GLOOMY OUTLOOK

While individual institutions may be reluctant to criticise China’s current policy decisions, foreign business owners say the ongoing pandemic situation, with mass lockdowns, manufacturing, services and logistics operating at low productivity, is the biggest risk they face.

A survey by the US and China Business Council (USCBC) showed that only half of the respondents expressed any degree of optimism about their five-year business outlook in China.

According to the report, based on an annual survey of 117 member companies, 96% were negatively impacted by China’s pandemic control measures, with more than half delaying or cancelling altogether their investment plans in the country.

Some 44% said it would "take years to restore business confidence," USCBC said.

PRAGMATISM PREVAILS

Andy Rothman, investment strategist at Matthews Asia, sees this as an important moment in US and China relations and suggests we are likely to see a return to pragmatism by China’s leaders. In particular, the plan to resolve the audit issue which risked the delisting of all Chinese companies trading on US exchanges, is important, he said.

“The significance of resolving this long-running regulatory dispute goes beyond the immediate impact of keeping over 200 Chinese companies trading in the US,” said Rothman. The audit deal is a practical decision by Chinese leader Xi Jinping to avoid financial decoupling from the US, Rothman believes.

The US Public Company Accounting Oversight Board (PCAOB) has reached agreement with Chinese regulators on a process for the PCAOB to inspect the audit workbooks of accounting firms working for Chinese companies listed on US securities exchanges. Trial inspections are beginning this month.

“In my view, the agreement reflects a return to pragmatism by Xi, suggesting that a more pragmatic approach to Covid and the property market may be coming, which I believe would pave the way for an economic recovery in China.”

It is not as if Chinese companies want to avoid being audited, he added. “This is a government-to-government issue. If they don't resolve it, then potentially by the summer of 2024, we could see forced de-listings.”

The China Securities Regulatory Commission (CSRC) expressed optimism, saying it is “committed to working with U.S. regulators” and that it is “hopeful that the audit oversight issue of the US-listed Chinese companies will be resolved and delisting can be avoided.”

SEC Chair Gary Gensler emphasized this point: “The proof will be in the pudding. This agreement will be meaningful only if the PCAOB can actually inspect and completely audit firms in China.”