China: defying deglobalisation

Relations between the US and China have deteriorated significantly during the Trump administration and this decline is gathering pace. In recent months, the tit-for-tat of trade war tariffs has moved on to political expulsions and attempts to block business. US-led encouragement for other nations to also decouple from China has also been amplified by the Covid-19 pandemic, as factory shut-downs prompted many manufacturers to relocate their global supply chains. Given China’s ascent to the top tier of the world’s economies has been largely driven by globalisation, will this de-globalisation trend impact its economic progress going forward?

The ongoing Sino-US trade war shows little sign of easing, despite the signing of the ‘phase one’ trade agreement at the start of the year. The pandemic has added to the de-globalisation pressures impacting China as both countries and companies consider moving supply chains elsewhere to diversify risk, especially in relation to the production of strategic goods.

Where once, China’s tensions with the US were seen as a symptom of the Trump presidency, the process of decoupling is unlikely to be reversed with a change of the US administration in November. One of the few things Democrats and Republicans agree on is the perceived need to contain the rise of China.

Yet, the world’s integrated supply chains are deeply intertwined, and this is not something that can be unwound quickly. This is especially the case for the US, with a 2019 survey finding that 95% of US companies were invested in China for its domestic market and 87% had no intention of leaving¹. This means any decoupling from the world’s second-largest economy is likely to be protracted. But how prepared is China to face this apparent reversal of fortune?

Covid-19’s impact on the Chinese economy has proven to be less detrimental than for many western countries. The nation already seems to be experiencing a classic V-shaped recovery. After contracting by 6.8% year-on-year in the first quarter, the economy rebounded by 3.2% year-on-year in the second quarter and full year growth is expected to be around 2.3% year-on-year for 2020 and 6.6% year-on-year in 2021².

This suggests neither the pandemic or deglobalisation trends have caused a major derailment of Beijing’s policy direction and growth aspirations. If anything, this year’s events may have prompted the government to speed up plans to transform its growth model.

The centrepiece of China’s foreign policy continues to be its Belt and Road initiative, which involves significant global infrastructure development across nearly 70 mainly developing nations. By funding these vital projects, China looks set to maintain its global network of influence.

Yet in May, the regime implemented a significant policy shift to promote increased self-sufficiency based on the understanding that it can no longer rely on global integration as a growth driver. By transforming its economy to focus more extensively on domestic demand, the government aims to hedge these external risks and sustain its growth trajectory. And with a population of close to 1.5 billion³, it effectively has an established internal market to support this self-sufficiency agenda.

The government’s focus on the domestic market, or ‘internal circulation’, will emphasise high-end manufacturing and technology and redirect Chinese consumers’ vast overseas spending (USD 250 billion a year is spent by Chinese outbound tourism alone) to the domestic market.

At the same time, it aims to reinforce its position as Asia’s economic super-power by engaging regional and global capital, financial and technological markets to drive growth throughout Asia.

China’s shift to this domestically-orientated growth model has helped underpin its V-shaped economic recovery this year. It also illustrates the resilience of its growth momentum and its policy leeway to boost growth. In fact, the nation’s growth is likely to continue to outperform that of developed markets in coming years irrespective of the deglobalisation trend.

Technology has been at the forefront of China’s growth model since 2013, when President Xi Jinping first came to power. Given the prevalence of US super-players in the technology sector, the onus on tech growth has thus-far been more domestically focused. Although emerging nations have also been a sizeable export market for China’s technology industry, benefiting from the relationships and infrastructure established through its Belt and Road Initiative.

That said, a few brands have broken through internationally. One of the leading phone manufacturers has gained success building lower-priced smartphones – and now reflects its own decoupling agenda as new models no longer rely on US-manufactured chips. Its growth has seen US rivals face substitution risk in the Chinese market (where it has also been hailed as a key provider of 5G infrastructure), as well as elsewhere. Such is the scale of its success, that the US has aggressively attempted to block use of the company’s technology not only in US operations but also those of its allies, citing security fears.

Chinese brands are also getting international prominence in the fields of video-sharing social networks, e-commerce and mobile payment providers. In particular, regarding the last sector, the initial public offering of its leading financial technology group is expected to be one of the world’s largest, valued at between USD 200 – 300 billion.

China’s other industrial successes have been more under the radar, given their domestic focus. Government efforts to revolutionise its healthcare capability, by doubling the value of the industry to USD 2.3 billion by 2030⁴, has had a transformative effect. Previously, while China’s wealthiest citizens could go abroad for medicines and treatments, its poorest had very limited options. The nation now aims to provide better, faster and cheaper healthcare than anywhere else in the globe.

Despite its reputation of being a laggard in the fight against climate change, China has actually become one of the biggest adopters of electronic vehicles, accounting for more than one million sales last year, and also dominates the global charging infrastructure market.

This adoption of electronic vehicles is part of its wider ‘Made in China 2025 Plan’ which includes plans to reduce emissions and establish energy independence as part of its economic goals. Moreover, the nation recently pledged to become carbon neutral by 2060, a sign of the governments’ commitment to global climate change goals. While this is a considerable step forward, little clarification has so far been given as to how this change will be achieved, especially since it currently relies on fossil fuels for nearly 85% of its energy needs.

While its growth credentials are almost unrivalled at present, despite the dual headwinds of the pandemic and deglobalisation, China still remains a conundrum for investors. The desire for investments to align positively with environmental, social and governance (ESG) criteria has gained more importance during this year of instability. But, despite China’s move towards greener environmental initiatives, some of its social policies – including the new security laws in Hong Kong and the mass imprisonment of the Uighur minority – create discomfort internationally.

At BNP Paribas Asset Management, we recognise that China will increasingly be an important investment focus we have investment experts dedicated to helping our clients navigate this complex region. The many opportunities presented in China can be accessed thematically – via technology, healthcare and infrastructure, as well as more directly. Our ethos of investigating before we invest seeks to identify those investment opportunities that generate sustainable long-term returns for our customers, ensuring responsible investment values remain central to our investment approach.

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