Is China a Bigger Risk Than Brexit?

China's capital misallocation, rising share of global exports and currency on the slide are the global economy's biggest threats over the long term

Karen Kwok 27 July, 2016 | 3:46PM
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China is a bigger threat to the global economy than Brexit, according to Gareth Lewis, chief investment officer at Tilney Investment Management.

“We expect the Chinese currency devaluation to continue driving global deflation,” Lewis told reporters at a briefing in London this week, predicting that the currency will devalue through 2017.

Extreme capital misallocation is the main driver behind the devaluation, Lewis said. Since the banking crisis in 2008, Chinese bank debt increased from $2.1 trillion to $28.2 trillion; greater than the debt levels built by the US banking system in the whole 20th century. Lewis believes that kind of credit growth is unsustainable and both the magnitude and speed of investment suggests capital misallocation.

Another problem China facing is that too much of the capital is state-directed. State-owned companies allocated cash limits the efficiency of the investment process. Without private sector investment China will struggle to create a sustainable long-term economic model. Lewis says the Chinese government agenda currently focuses too much on keeping up its GDP growth above 6.5% and employment growth high.

Long Term Structural Concerns

Other professional investors share the same concerns over China’s long term prospects. Will Ballard, head of emerging market and Asia Pacific equities at Aviva Investors, agrees, saying that China has long term structural concerns.

“We’re paying close attention to market liquidity conditions, global funding stresses and capital flows in China,” Richard Turnill, BlackRock’s global chief investment strategist pitched in.

Lewis continued: “The truth is China’s economy with its size, probably needs only to grow 3.5 or 4% to be a well-balanced economy. The transition from where it was to a balanced level will be painful, but I think China as a dominated power on the global economy is not going away.”

Concerns were also raised over the record level of China’s share of global exports. China’s proportion of global exports rose to 13.8% in 2015 from 12.3% in 2014, according to data from the United Nations Conference on Trade and Employment, the highest level any country has been since the US in 1968.

While China’s share of global exports is at a record level, world trade is declining, leaving a question as to where their exports will go. This will swamp the global market with excess inventory that could trigger global deflation, Lewis warned.

With all these issues combined, China poses as a bigger challenge than Brexit to the global economy he argues.

“While a Chinese hard landing is by no means guaranteed, the risks are growing,” Lewis said.

There is a risk that the Chinese government will resist necessary reforms, burying their problems for this year, and setting a much lower GDP target the earliest second half of 2017, or even the year after.

Asia Growth Still Attractive to Investors

Despite many negative headlines about China’s growth and its currency, Asia as a whole is achieving much faster rates of economic growth than rest of the world.

“Brexit itself is not a reason to turn your attention to Asia. Asia is not perfect by any means, but it seems to me to still be on the right track,” said Robert Horrocks, chief investment officer at Matthews Asia.

Using Morningstar Fund Screener, we found top rated funds that offer exposure to Asia. The Gold Rated First State Asia Equity Plus Fund offered exposure to Asia ex-Japan equities with a 20% return year to date. Gold Rated Schroder Asian Opportunities also offers the same exposure with a 21.3% return year to date. Silver Rated Aberdeen Asia Pacific and Japan Equity also delivers 20% return year to date with an exposure to Asia Pacific region, including Japan.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk