The China Recovery Brings Risks to Emerging Market Investors

Global central banks have been largely accommodative as they battle the impacts of the pandemic on their economies. Lower rates and liquidity have helped push economies ahead and through the worst of the Covid-19 crisis. While accommodative monetary and fiscal policy actions are set to continue for the U.S., China, which experienced an expeditious recovery, has reversed course. As exhibit 1 shows, China’s economy has recovered much more quickly from the pandemic than other major economies.

Fears of both an overheated equity and real estate markets have prompted a tightening in policies aimed to pull liquidity from China’s system. While the People’s Bank of China (PBOC) has not raised its key interest rate yet, the PBOC could be the first major central bank to do so.

As the PBOC continues with a liquidity reducing policy, we expect to see Chinese equities underperform other markets. This could be the case despite expectations for a pick-up in domestic activity and exports as global economies reopen and Chinese Covid-19 bans are lifted.

The impact of contractionary PBOC policies aimed to cool off financial and real estate markets has already become evident. Like other central banks, the PBOC walks a fine line between controlling inflation while promoting growth. While their policies thus far have been more targeted to deter speculative behavior and prevent asset bubbles, there could be unintended consequences. There may be enough positive fundamentals that the market could weather the PBOC tightening. However, it is usually a better bet to move out of a central bank’s way.

We think that the PBOC’s shift away from accommodative policy has implications for emerging market investors. For example, China makes up a large percentage of key emerging markets indices and relevant investment products (exhibit 2). With China’s tightening cycle and rate hikes approaching, Chinese equities could struggle. Investors may want to sidestep these risks.


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The MSCI Emerging Markets Index captures large and mid-cap representation across 27 Emerging Markets (EM) countries. With 1,391 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.