2023 preview: China macro

The speed at which China is opening up is beyond the expectations of even some of the most ardent optimists.

In the past two weeks, Beijing has made a U-turn on its COVID-19 control policy, with medical authorities finally setting the tone that the omicron variant is less deadly than the flu. The country has put an end to the zero-COVID policy. No test result is needed for internal travel, patients can quarantine at home, and Hong Kong expects free entry into the mainland as soon as in January.

“The speed of opening up is key because mobility is closely correlated with China’s consumption and economic activity, more generally. In fact, we have estimated that, in the course of 2022, the reduction of mobility due to COVID restrictions should have shaved off as much as 2.5 percentage points of GDP growth,” said Alicia Garcia Herrero, chief Asia Pacific economist at Natixis.

Investors have struggled to get to grips with China over the past 18 months. Despite the country’s track record of policy surprises, the intensity and scope of intervention since mid-2021 were unprecedented: from the erasing of the entire afterschool tuition industry to the investigation into Didi Chuxing that led to a suspension of all US IPOs to the crackdowns on internet platforms and property developers.

“China has reached a new stage of development where ESG [environment, social, and governance] is a bigger consideration. If an investment doesn’t correspond to ESG principles, it could be a problem,” said Mengyang Yang, an executive director and head of Hong Kong private equity at CICC Capital.

She cites after-school tuition as an example. If the sector grows at the expense of the mental and physical health of students and increases the costs of raising children, it is problematic.

Social effects are frequently quoted by investors as a new key to understanding the future investment environment. “Measurable ESG due diligence and implementation of quantitative ESG enhancement measures will become one of the top priorities of GPs that continue to secure funding from institutional LPs that are willing to put allocation in China,” said Maureen Ho, a partner of Morrison Forester.

Growth agenda

However, a lingering question is whether China is still the country that puts the highest priority on economic development and poverty eradication.

One private equity investor told AVCJ that his team has carefully studied the report from the latest Communist Party congress and found fewer references to “fight” or “fighting” than in the report from the previous plenum. On the Taiwan issue, where investors are concerned about the possibility of armed conflict, there is no mention of such a plan.

The most concrete goal in the report is to make China a “medium-developed country” by 2035. This means doubling the scale of the economy from 2020 levels by 2035, which would indicate an average annual growth rate of 4.7%. And that is something not to miss.

Ensuring sold GDP growth is the top priority for 2023, according to Hao Hong, a former China strategist at BoCom International, who resigned earlier this year following bearish reports on the country. While some argue that the COVID-19 policy shift was due to the protests over strict controls in certain cities, others believe that opening up was part of a clear trend and a decision based on economic data.

Noting that China’s export growth turned negative in October for the first time in 29 months, Hong claims that one wheel of China’s “dual circulation” strategy is starting to fail. Tighter US monetary policy is impacting demand for export, while retail sales growth, a measure of domestic demand, also slipped into negative territory in October. That’s the other dual circulation wheel stuck in reverse.

“If exports, consumption, and investment cannot support the economy, while government spending is strained by declining land sales, the outlook for 2023 would appear bleak. To resist such gloom, it is time for China to reopen,” said Hong.

The speed of the opening up, while beyond expectation, is not altogether surprising. China is a country well known for its implementation efficiency. Once a course of action is decided, officials can implement it rapidly nationwide with little struggle. The atmosphere has changed overnight. Entrepreneurs describe it as the spring they’ve been waiting for; they can finally roll up their sleeves and get to work.

The economic recovery, however, is not straightforward. External demand will be weaker in 2023 due to recession in the US and Europe, according to Iris Pang, chief economist for Greater China at ING. This could also impact domestic consumption if wage growth in the manufacturing sector is sluggish.

Consumer was the hardest hit sector during the pandemic, but it is expected to be the first to revive, which is bringing back some confidence. Citing a record high of China household savings deposits of USD 1.4trn in the first half of 2022, Scott Chen, an Asia managing partner at consumer-focused L Catterton, believes there is capacity to resume spending with the opening up.

“History has also shown that consumer sentiment and spending often quickly rebound after each downturn, and we expect that to be the case too over the coming year,” Chen said. “The path to recovery and growth, however, will not be linear and there will be some ups and downs from an economic and public health standpoint, like what other countries have experienced.”

Chen regards the consumer sector as attractive from a medium- to long-term perspective given it is underpinned by robust fundamentals and secular tailwinds. Meanwhile, with founders and management teams tempering their valuation expectations, conditions are more conducive to negotiating favourable terms with reasonable governance rights and downside protection.

This view is echoed by Zhanbin Dong, a managing partner of Qingsong Fund. He observed that company valuations in the consumer sector are at a historic low, suggesting that private market deals are available at price-to-sales ratios of approximately 2, a significant drop from 2020 and 2021.

Hyomi Jie, a portfolio manager at Fidelity International, also sees opportunity in the sector. “Self-sufficiency and import substitution will be significant themes over the next five years. As such, domestic brands and high-end manufacturing and consumer services could benefit from accelerating supply-chain localisation in China. The premiumisation trend has also demonstrated resilience despite recent negative economic news and will continue to offer long-term structural opportunities.”

Stick or twist?

While venture capitalists will respond fast to market recovery, overseas LPs may need longer to reconstruct their confidence. One placement agent estimates that around one-third of LPs previously active in China will not return, given changes in the perceived risk premium versus other markets. However, this view is not shared by all.

“We have actually seen some foreign capital begin to come back quietly. In the first three quarters of the year, foreign capital basically lay flat and their people disappeared. Entering the last quarter of the year, we started to see them again. Now the economic situation at home and tension abroad are easing, foreign capital won’t miss opportunities to make money,” said Qizhi Guo, a senior partner at CDH Investments.

CICC Capital’s Yang added that based on China’s economic scale, many investors are already under-allocated to the country. Once the country opens up, institutional investors may quickly adjust their portfolio allocations. Investors unfamiliar with the market may dip a toe, withdraw, and then try again. Those with a better understanding will show a continued interest in opportunities.

Another factor that makes China more attractive in 2023 is the notion that it is one of few countries where interest rates are being lowered in an attempt to boost the economy and support the property market. In other parts of the world, higher rates have increased financing costs and inevitably slowed new investments, according to Morrison Forester’s Ho.

Mounting challenges facing many developed markets – from inflationary pressure to energy crises to recession risks – may also work in China’s favour. “China’s more supportive central bank policy and the shift in its policy focus towards stability and economic development should boost the attractiveness for international investors looking to diversify their developed-market exposure,” said Fidelity’s Jie.

Capital flight remains a concern. Payment Asia, a Hong Kong-based start-up, has tracked high net worth individuals (HNWIs) moving their wealth offshore. It claims the number of trusts set up by Chinese HNWIs in Singapore rose 44% year-on-year in 2022, the highest rate of growth in five years.

However, Harvey Chan, business development director at Payment Asia, believes that the peak has passed – which may be an indicator of improved sentiment toward China.

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• Topics
• Greater China
• Expansion
• Fundraising
• China
• Economy
• CDH Investments Management
• L Catterton
• CICC
• Qingsong Fund