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November 2017

Emerging Markets Monitor

Pictet Asset Management’s monthly selection of the key charts and data trends to watch in the emerging market space. 


Sizing up China

It has become a cliché to talk about just
Fig.1. China T-Shirt production 

An example of the nation's overcapacity

China tshirt production

Source: Yi Wen (2015) The making of an economic superpower – Unlocking China’s secret of rapid industrialization, Working Paper, Federal Reserve Bank of St. Louis.


how big China is and its manufacturing output.

For example, almost one out of four manufactured goods is produced in China.

Today, Chinese policymakers are walking a tight rope to cut debt levels and rebalance the economy.

The big question is: how much growth will they sacrifice in the process?

What does China's policy mix mean for growth?

Policies outlined at last month's 19th National Congress, aimed by Xi Jinping at producing a "better life" for China’s economy and people, suggest slower economic growth but, on balance, point to a more sustainable future for China. 

Fig.2. 19th China Party Congress: policy areas & implications

Source: Pictet Asset Management, November 2017

Looking at policy areas, the two stimulative initiatives may be ambitious but will not be enough to offset the impact of restrictive ones.

More details will be disclosed  in late December at the Central Economic Work Conference.

Could debt levels cause a crisis?

Currently at 250 per cent of GDP, China's debt burden may be big but is still under control.

Fig.3. Total emerging debt by sector & by markets
Q1 2017, % GDP

Source: Pictet Asset Management, BIS, CEIC, Datastream, data as at Q1 2017

The main risks are the financial liberalisation and the opening up of the capital account, which have been catalysts in previous EM financial crises. There are however mitigating factors, most importantly:

  1. the government owns the main creditors (large banks) and debtors (2/3 of corporate debt is SOE)
  2. Chinese debt is still essentially domestically held.
Read more

What's China doing to manage its debt levels?

Fig.4. Chinese policy, short and long-term rates

Source: Pictet Asset Management, CEIC, Datastream, data to 13/11/2017

Tighter monetary policy has helped mitigate the risks posed by China's debt burden. Since late last year, monetary authorities have allowed a steady increase in money market rates. As a result, interest rates have bounced from their lows in October 2016 (Fig.4).

This tightening helps anchor RMB expectations ahead of the US rate tightening cycle by containing the interest rate spread between China and the US.

What rates of growth can we expect in the next decade?

China’s economy is maturing: it has become the world's third largest debt market, second largest economy and since 2010, the largest manufacturer. But its corporate sector is massively over-leveraged. And history shows that this tends to lead to lower future growth rates.

What growth rate can we expect in future? 

We have estimated the growth trajectory based on three calculation models: leverage levels seven years prior and post their peak, GDP per capita and production factors (Fig.5).

All three approaches point to growth of 4 to 5 per cent over the next 5-7 years.

We therefore expect growth targets to be lowered over the next few years, starting next year, while the rebalancing of the economy should continue from investment towards consumption.

Fig.5. Chinese GDP growth by Production contribution factors
Where production function is of the type: Y=A∙F(K,N)

Source: Pictet Asset Management, CEIC, Datastream. Data to January 2016 except for potential growth data which is up to January 2020.  *Mixed forecasting: non-accelerating inflation growth of output, HP filtering, working-age population. 



The city of Shenzhen in China. 


Our EM equity team's view

By Gita Ramakrishnan, Senior Investment Manager

All’s well that ends well?-  China’s State-Owned Enterprise (SOE) reforms

After many previous false starts, we are increasingly optimistic about the scope for proposed reforms of China’s State Owned Enterprises (SOEs) to positively impact shareholder returns. 

Although complicated, we believe SOE reforms are likely to increase capital efficiency and lead to higher equity returns via increased dividends and cash returns.

Fig.6. EM dividend yield vs. ROE

Higher dividends and cash returns should lead to higher equity returns in China.


Source: Bloomberg, data as at 13/11/2017

A key factor is the level of surplus cash on SOE balance sheets which offsets the high levels of debt in the system.

Because A-shares are gradually going to be included in the MSCI EM index starting next year, this is a significant development for all investors in emerging markets.

We are currently working on a longer paper on this topic. Please contact us if you are interested to find out more.


Market watch

Fig.7. Key Market data



Source: Datastream, Bloomberg, data as at 31/10/2017 and in USD. Equity indices are quoted on a net dividend reinvested basis; bond and commodity indices are quoted on a total return basis. The currency rates evolution is treated as a performance calculation based on FX rates.