Has China broken the ‘doom-loop’? An Asia credit perspective

The confluence of disinflationary trends taking hold in the US, and a decisive turn in Chinese policy, has broken the doom-loop for Chinese assets and Asian credit which has plagued markets since the third quarter of 2021.

 

Need to know China’s leaders have moved further and faster than expected in rolling back restrictive pandemic measures. At the same time, officials have initiated support for property developers A full recovery is expected to take some time, but there are already encouraging signs in transportation, retail sales, recreation and home sales China’s reopening and strong economic policy support measures will likely prove supportive for the Asian credit market

 

China gets back on track

China has made two sweeping policy changes since November. First, it has dismantled various key zero-Covid pandemic control measures. Second, it has provided supportive policies for key and large remaining property developers to help resurrect them. The policy measures are the strongest, clearest and most positive ones yet, and are all being done to ensure China gets back on the path of economic growth.

China’s significant policy pivot was unexpected. Market consensus had it that China would loosen its zero-Covid policy in the second quarter of next year after the Party congress’s economic meeting in March, and even the most optimistic projections had it that China would only abandon its zero-Covid stance ‘abruptly’ in April 2023. However, China’s leaders have now surprised everyone with officials downplaying the risk of Covid, with a top medical adviser saying that the fatality rate from the omicron variant is in line with influenza.

 

The world’s largest post-pandemic reopening?

A complete return to normal in China will take at least another six months, but economic activity is likely to bottom out now or in early 2023. Green shoots are already emerging for transportation, retail sales, recreation and even home sales in December as mobility improves. This will now likely mark the largest post-Covid reopening in the world, which will play out in 2023.

However, we believe a recovery in consumer sentiment and retail spending will happen gradually as Chinese households did not get cash handouts like those in the US and Europe. Additionally, the real estate crisis, as well as deteriorating household balance sheets, created negative wealth effects which will take time to reverse. The flip side of this is that the economic and corporate earnings recovery will be prolonged, similar to that of the US after the 2008 financial crisis, and investors are likely to have ample opportunity to benefit from the recovery across credit and equities for many quarters.

Within the property sector, which continues to generate at least quarter of the nation’s GDP, China has announced that its key mega and policy banks will provide as much as RMB 1.5-2 trillion in credit lines and liquidity support to the top dozen property developers, including key large private sector ones. We expect the industry to achieve net cash flow breakeven in the first half of 2023 and to return to pre-Covid utilisation and revenue levels in 2024.

 

Looking beyond China

Overall, we expect the Asian credit market to continue enjoying strong tailwinds from China’s reopening and strong economic policies. The lack of new Asian primary-market debt issuance, high fund cash balances, investors’ defensive positioning and lack of secondary bonds on dealer balance sheets are further driving the market higher. We have also noticed inflows returning to the asset class.

Away from China, there are secular growth and investment trends emerging in India and Indonesia, which should support a strong growth trajectory in both those economies. For India, infrastructure investing has been at decade highs over the past two years. Bank balance sheets are much stronger with higher profitability and better asset quality. Bank credit growth is now at an 8-year high, supporting growth in the system. Going into next year, private capex should also start to support growth and we expect to be around 6.5-7% next year as well. Indonesia is also seeing continued foreign direct investment (FDI) inflows as they expand their electric vehicle (EV) supply chain capabilities further, which should continue to support their growth resilience into next year.

The expected relative improvement in the fundamentals in Asia into 2023 is yet to be reflected in valuations. Valuation differentials versus US credit is still close to the wides at the moment.

Possible US policy and Treasury yield paths, China’s grand reopening and its implications, the secular growth for South & South East Asia, Asia credit primary supply outlook, the changing face of Asia high yield (HY) and top opportunities for the coming year will feature in the 2023 Asia fixed income outlook next month.

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