Targeted measures from China’s NPC brings some cheer to selected sectors

Targeted measures from China’s NPC brings some cheer to selected sectors

Beijing’s targeted measures introduced at its recently-concluded annual legislative meeting were seen as the first responses to COVID-19 lockdowns. Chris Liu analyzes the impact of what the measures have on Chinese companies and China A shares.

China’s top legislative body, the National People’s Congress, ended its annual meeting on May 28. As the first major economy to be hit by the COVID-19 pandemic and the first to gradually step out of its shadow, what measures were announced at the NPC meeting was widely viewed as a blueprint for how to get the world’s second largest economy back to business as usual.

In this article I examine the impact of what the measures have on Chinese companies and China A shares.

Small caps should benefit from increasing market liquidity

Despite the pandemic, market liquidity was higher in April 2020 than a year ago, with total social financing (TSF) and M2 up by 12% and 11% respectively1. I think there might be more room to further increase the credit growth in the coming months: during the NPC meeting, the central government vowed to guide TSF and M2 growth “significantly” higher than in 2019, and also to drive reserve requirement ratio (RRR) and interest rates down for the rest of the year. This really sets the tone that abundant market liquidity will remain for the China A share market for rest of 2020. Since the A-share market is a liquidity-driven market, especially for small caps, we expect the market to be well-supported by the current loosening liquidity environment, and the small caps’ outperformance should continue.

Financial market reforms to improve price-discovery mechanism in stock market

The central government’s economic work report mentioned that it will fast track the launch of a registration-based IPO system for the ChiNext board in Shenzhen. This reform will have a profound impact on listed companies and institutional investors. By making it more straightforward to get listed, the value of poorly-performing listed companies will decrease dramatically: not only will those listed companies that have poor fundamentals and bad corporate governance face huge share price downward pressure, they will also be less attractive to companies that want to list through backdoor listings under the old regime. I expect that with regulators strengthening penalties and delisting standards for poor quality assets, structural risks in the A-share market for investors is reduced.

Infrastructure to benefit

Contrary to tradition, Beijing did not set an official GDP growth target for 2020 due to uncertainties from the pandemic. Not setting an official target alleviates the pressure to stimulate the economy, unlike in 2008 when local and provincial governments pursued growth at all costs by investing in large infrastructure projects. This time, China is focusing on high-tech infrastructure (termed “new infrastructure” in China) because these projects they have higher multiplier effects, and could create new consumption demand in the areas where China has clear technology advantages, such as: 5G, charging stations for new -energy vehicles charging stations, Internet data centers, etc.

Even though we expect sectors such as telecom equipment, computer hardware and electric equipment to benefit from the stimulus announced during the NPC meeting, these sectors have had a big run in the lead up to the meeting. Valuations of some stocks, especially small-cap stocks, are already at a very high level. Stock picking, rather than a broader sector exposure, becomes more important, and this requires a focus on finding companies that have long-term competitive advantages in those sectors.

Considering that “new infrastructure” still accounts for only a small part of all infrastructure projects, a big part of the fiscal expansion announced during the NPC meeting will still be spent on traditional infrastructure projects such as high-speed railways, subways, etc. With RMB3.75trn local-government special bond issuance in 2020 (up by RMB1.6trn from 2019)2, a higher 2020 completion target for new rail tracks, and additional funding of RMB100bn for railways3, I anticipate that investment in China’s infrastructure is likely to chalk up double-digit growth in 2020.

Among the different segments, I expect construction, building materials and construction machinery sectors to benefit greatly. Moreover, in addition to the short-term demand boost by the infrastructure spending, building materials and construction machinery sectors should also profit from long-term drivers, such as tight regulations on supply side and industry consolidation (e.g: building materials, especially cement), and import substitution for the construction-machinery sector.

Recovery in discretionary consumer sector linked to employment

The service and consumer sectors have been recovering at a slower pace than the production and manufacturing sectors. On top of consumers’ cautiousness to head outdoors to shop, eat and entertain, higher unemployment is also a reason for the weak recovery. Employment is the important for consumer confidence and consumption recovery. Beijing’s economic work report wrote that new tax cuts and fee reductions are projected to be around RMB2.5trn this year to help SMEs4  – taken as a whole, they are the most important employer in China’s economy. The central government also vowed to use a mix of fiscal, monetary and investment policy tools to stabilize employment this year, and create 9 million new jobs in 2020.

China’s discretionary-consumer sector was hit badly during the pandemic, and I expect the auto and home-appliances segments to benefit from the supportive fiscal policies aimed at stabilizing of employment. Other service segments such as catering, retail, tourism, etc. will be supported by policies such as announced cuts to social security expenses, exemption of service value-added tax, postponement of income tax for SMEs, and issuing consumption coupons to the low-income consumer group.

Banking sector in good position to support measures

NPC’s economic work paper mentioned that large banks are required to deliver 40% credit growth for the SMEs loans5, while many micro loans and SMEs loans will be extended to end of March next year, and loan prime rates (LPR) might be cut further.

These “national service” measures will weigh on banks’ net interest margins (NIM) and NPLs, however, considering that the SME loan only accounts a very small part of large banks’ loan books, and that the large banks have very high loan provisions against NPLs, the measures’ overall impact on large banks is not expected to be that big.

Stimulus unlikely for property sector

The NPC’s work report reiterated the central government’s view that “houses are for living, not for speculation”. As such, I expect that broad stimulus for the property market is still unlikely this year. However, I see some possibilities for localized support: the report also mentioned that the policies could be tweaked for different cities, and more flexibility can be given to local governments.

Property tax is not mentioned in the work report, which I view as good news for the sector. Property sales data has gradually recovered from the pandemic especially in the higher tier cities, with market leaders seeing much better property-sales recovery as compared to the industrial average. The central government pledged to begin the renovation of 39,000 old residential communities in urban areas, an increase from 19,000 in 20196. This renewal plan will help stimulate more property demand. Currently, Chinese property stocks are trading at very cheap PE and P/NAV7 (price to net asset value) valuations, and the whole sector has been lagging the overall A-share market in the recent market recovery from the pandemic.

Chris Liu is Senior Portfolio Manager at Invesco.

^1 Source: Bloomberg, as of May 11, 2020.

^2 Source: “China Abandons Hard Growth Target, Shifts Stimulus Focus to Jobs”, Bloomberg News, published May 22, 2020.

^3 Source: “China decides not to set a GDP target for 2020 as coronavirus batters the economy”, CNBC, published May 21, 2020.

^4 Source: “China to reduce corporate burden by over 2.5 trillion yuan in 2020”, Xinhua News Agency, published May 22, 2020.

^5 Source: “China’s pandemic lifeline for small firms draws lukewarm response from business owners”, South China Morning Post, published May 22, 2020.

^6 Source: “Premier Li sets out China's plan to overcome COVID-19 challenges”, CCTV English, published May 23, 2020.

^7 Source: Wind, Invesco’s analysis as of June 1, 2020.