Go for lower, higher-quality growth
追求缓慢但更高质量的增长

By Morgan Brady

China’s response to the pandemic has been remarkable. The U.S. has also responded relatively well from an economic perspective.
 

China’s combination of monetary and fiscal policy support, COVID-19 restrictions and rapid, widespread testing has helped a strong economic recovery. China’s economy expanded in Q2 and Q3 after a deep decline in Q1.
 

China’s economy is now expected to expand by 2.1% in 2020, down slightly from the 2.2% growth projected in July. That would make China the only major economy to grow in 2020, albeit at the slowest annual pace since 1976.

The COVID-19 recession is now a thing of the past in China. Chinese policymakers will turn to the medium-term to ensure the actions taken in the near-term are not wasted. During the last week of October, in a four-day meeting known as the plenum, the Communist Party’s Central Committee focused on China’s 14th five-year plan. The framework will target the years from 2021 to 2025.
 

Recent five-year plans have moved China’s growth targets lower. China has focused on improving the quality of growth instead of maximizing the speed of growth.
 

Domestic growth has been key. Domestic consumption contributes almost 60% of China’s GDP growth. Net exports, on the other hand, have averaged zero contribution to China’s GDP growth over the past five years.
 

The next five years will see a growing focus on domestic economic development. This will be part of the so-called “dual circulation” strategy.
 

中国对新冠疫情的应对非常积极，而成果也非常耀眼，经济迅速复苏。在第一季度大幅下滑之后，中国的经济在第二季度和第三季度持续进行增长。国际货币基金组织（International Monetary Fund）预测，中国将成为2020年唯一增长了的主要经济体。现在预计，中国的经济在2020年将增长2.1％。这是自1976年以来最慢的年度增长速度。在为期四天的全体会议上，中国共产党中央委员会将重点放在了中国的第十四个五年计划上。该框架的主体是2021年至2025年。五年计划已经降低了中国的增长目标。现在，中国要专注于提高增长质量，而不是增长的速度。国内消费几乎占中国GDP增长的60％，因此国内的经济状况非常关键。未来五年，人们将越来越重视国内经济发展。这将是所谓的“双重循环”战略的一部分。
 

Upgrading technology, increasing labour mobility

China's top leadership has signalled that the country will focus on boosting the domestic supply chain and homegrown innovation to become completely self-reliant in economy and core technologies.
 

That will include a clear aim for technological progress and upgrading technology. Research and development budgets will probably be expanded in areas like robotics, 5G, semiconductors and artificial intelligence. Urbanization will be a big drive, including plans to further develop metropolitan areas and increase labour mobility by relaxing hukou restrictions. I also expect explicit support for private sector and SME growth including better access to credit.
 

China’s growth target is probably going to be closer to 5%. This compares to 6.5% in the last five-year plan. If a 5% target is achieved, China will move to being a high-income country by 2025. China’s economy would surpass the U.S. within the next decade.
 

This trajectory will do little to ease U.S.-Chinese political tensions. Those tensions look set to persist regardless of who wins the U.S. Presidential election. And those tensions, which now look structural, will almost certainly add to the focus on domestic growth and self-reliance in the upcoming five-year plan.
 

But don’t expect China to turn inward completely. China has been on a financial reform path for much of the last decade. Capital market liberalisation has helped reduce some of the potential medium-term risks from a messy credit deleveraging. President Xi has also indicated that China will open further to foreign capital and competition. The focus on higher quality growth, mentioned above will be key in attracting foreign direct investments and portfolio inflows.

China’s authorities should not waste this recession. Now is the time to deepen financial reforms. China can further boost the role of capital markets and reduce the reliance on state-owned banks for funding. That will continue to alleviate the risks around capital misallocation, and those risks from a messy credit deleveraging will decline further, improving the economic outlook.
 

Investors need to focus on the medium-term. The plenum has a history of driving near-term Chinese equity market volatility. In 2015, for example, the five-year plan ended China’s one-child policy. Stocks that were related to child-care surged following the announcement. China’s onshore equity market is still prone to significant momentum, sentiment and speculation driven swings in response to policy announcements. That means potential near-term risk for sectors like renewables, technology, finance and defence.
 

But sensible investors should look beyond the near-term and see the bigger picture. And the bigger picture is that the five-year plan will refocus China’s attention on medium-term outcomes. And those outcomes are likely to be an ongoing recovery with China’s economic growth path remaining on a solid trajectory.
 

China’s equity market has traded sideways in a relatively tight range since the rapid rally in early July. Yes, there is near-term potential for sentiment driven trades, momentum-driven movements and speculative volatility. But the point is, focusing on the fundamentals still leaves China’s onshore equity markets looking attractive.