Reform and Reflation in China

China’s National People’s Congress met in March, which seemed like a good backdrop for our annual Templeton Emerging Markets research meeting, which took place the same month in Shanghai, China.

Recently, a government crackdown on so- called “entrusted investments,” which are within the realm of “shadow banking,” caused some market turbulence. However, we think these efforts to effectively force some financial entities to deleverage are overdue.

Nonetheless, China remains one of the fastest-growing economies in the world, and we think rising incomes and the maturation of a young working population is likely to continue driving domestic demand. Moreover, China is gradually becoming less dependent on exports as the government implements structural, economic and financial reforms. China holds the largest foreign reserves in the world, making it less vulnerable to external financial shocks.

There are certainly concerns about the health of China’s economy—including rising debt—so we are mindful of potential volatility and remain watchful for risks. Some of these include changes in Chinese policies, the impact of US President Trump’s trade policy and other economic measures, changes in interest rates and exchange rate transformations.

China’s relationship with the United States has been thrust into an even brighter spotlight in recent days given the new US administration’s focus on trade relations—and in light of increased tensions with China’s neighbor, North Korea.

I’ve invited my colleague Eddie Chow, who is based in Hong Kong, to share some of the key themes we discussed at our research meeting. He provides an overview of China’s economy as well as potential areas of opportunity we see as investors.

China’s economy is in reflationary mode today, which makes us optimistic about the equity market’s prospects. The industrial sector has ended a five-year long period of deflation and we expect to see pick up in restocking and capital expenditures going forward. Stabilization of external demand (better export performance) also would support near-term growth momentum.

China’s economy is experiencing a cyclical upturn with private investments and industrial activities on the rise, and external demand stabilizing.

On the structural side, state-owned enterprise (SOE) reform has yielded positive results, with many companies now seeing stronger cash flows and balance sheet improvement. Supply-side reform is being well implemented, without much drag on the economy. Further implementation of reforms should prove market drivers, in our view.