What the West Misses About China

Many investors, particularly those living far from Asia, worry that China’s rising debt will plunge the world’s second-largest economy into a global financial crisis similar to that of 2008.

Local financial leaders, though, expressed a different view during an April 13 lunch hosted by Institutional Investor at the Foreign Correspondents Club in Hong Kong. Invited to discuss what global investors get wrong about Asian capital markets, the financiers dismissed fears of a crisis while making a case for optimism.

China is getting its financial house in order and may emerge as a capital markets powerhouse rivaling the U.S. in the coming decade, according to attendees Schulte Research International chief executive officer Paul Schulte, Robeco’s Victoria Mio, UBS Group’s Hu Yifan, and Old Mutual Global Investors’ Joshua Crabb. All have worked for global asset managers and banks in Asia, and though the topic of discussion was regional, the conversation tended to focus on China and how major investors err in increasingly worrying about the viability of its economy.

“China is never having a 2008 crisis — I don’t think it’s going to happen,” saysSchulte, the founder of his namesake firm in Hong Kong, which provides economic and market analysis for global sovereign wealth funds.

Schulte — an American who began his career in the 1980s as an analyst with the National Security Council under U.S. President Ronald Reagan and later worked in finance as an Asia strategist for Lehman Brothers Holdings and Nomura Holdings — has data supporting his view on China’s financial health. Despite a rapid rise in lending, the loan-to-deposit ratio in the nation’s banking sector stands at roughly 80 percent, he says, comparable to banks in the U.S. And its surplus incurrent accounts, a measure of a country’s trade balance, is about 1.8 percent of gross domestic product. The U.S., meanwhile, had a deficit in current accounts equaling 2.6 percent of GDP last year.

China’s current account surplus, which indicates its strength as an exporter of goods and services, is particularly important, notes Schulte. “When you are running current account surpluses of $550 [billion] and $600 billion annually, it means you are in control of your banking and financial system,” he says, adding that in the run-up to the financial crisis, the U.S. had an account deficit of about 5 percent of GDP.

Though its debt expansion has raised concerns, financial conditions in China are on the mend, according to Robeco’sMio, who is co-head of Asia Pacific equities and chief investment officer for China at the Dutch asset manager. The Rotterdam-based firm oversees $146 billion in assets, including $10 billion in Hong Kong, and is owned by Japanese financial conglomerate Orix Corp.

“The market has not fully priced in improvements in China,” says Mio, who manages a $440 million portfolio.

Mio cites a number of improvements in the country, including rising corporate earnings and accelerating GDP growth driven by consumption, investment and export. Global investors tend to look at the nation’s rising debt level, estimated to be as high as 270 percent of GDP, without accounting for tools, such as debt-for-equity swaps, that China is using to reduce leverage, she notes. Mio also believes that President Xi Jinping’s anticorruption campaign is paying off, pointing to the increasing transparency in China’s government and corporate sectors.

In another positive sign, cash flows of Chinese companies are rising, Mio says. The country’s producerprice index, a measure of inflation tied to prices of goods and services, climbed 7.6 percent in March from a year earlier, the seventh straight month of increases, according to data provider Trading Economics. Prices had contracted from early 2012 through most of 2016. This means government efforts to restructure state-owned enterprises are working, Mio says, adding that “this turnaround in cash flow” has not been recognized by many equity investors globally.

Hu, the Greater China chief investment officer for UBS’s wealth management unit, which has more than $1.7 trillion in assets, says she’s noticed that global investors are becoming less pessimistic about China. Hu predicts that MSCI could decide as soon as this year to include A shares of companies listed in mainland China in its emerging markets indices for the first time. “We see there is a higher chance of MSCI increasing exposure to Chinese equities,” she says.

中国的崩溃,或亚洲市场imminent, as many global investors have feared, agreesCrabb, the head of Asian equities for Old Mutual Global Investors, which has $36 billion in assets. He also looks at the other side of the globe to back up his conviction. “The U.S. markets are trading at three times book value,” says Crabb, an Australian managing a $750 million portfolio in Hong Kong. “Asian capital markets are trading at 1.6 times book value. If the markets are going to collapse, which is what many are predicting, Asia has to get more expensive first.”