Back in May 2018, the door opened just a crack. Now, it’s almost wide enough to squeeze through. One day, surely, it will likely be flung fully open. I am referring to the recent announcement from MSCI, one of the world’s largest index providers, to up the inclusion factor on China A-share in some of its indexes from 5% to 20% (in three additional 5% tranches this year).
As we said at the time of the first inclusion back in May 2018, the message that this sent, and the indication of the direction of travel was clear – China is a critical economy, it has earned its place on the world stage, and its capital markets are not far behind. Whether you choose to invest or not, we would argue that the Chinese A-share market (the onshore listed, yuan-denominated shares, as opposed to the offshore, Hong Kong dollar markets) can no longer be ignored. We believe Investors can, and should, at least wrestle with the potential impact that China A-share may have on portfolios.
Along with the now higher proportion of China A-shares that will enter the MSCI indexes, two aspects of the inclusion announcement were also of interest – the decision to include mid-cap securities, and the decision to include ChiNext stocks (think of ChiNext as the Nasdaq of China). The message is that we are now starting to see a little additional differentiation and diversification with the planned moves to go further down the market cap, and further towards the high-tech growth spectrum.
The announcement also makes now an opportune time to take stock of where the Chinese economy stands. And, with that goal in mind, I thought a brief contest was in order. So, welcome to…
Eight Rounds for the Economic Heavyweight Championship of the World
| China | United States | ||||
| Round | Boxonomics metric | 2019(F) | 2020(F) | 2019(F) | 2020(F) |
| 1 | GDP growth (%) | 6.0% | 6.0% | 2.6% | 2.1% |
| 2 | CPI inflation (%) | 1.5% | 1.8% | 2.1% | 2.1% |
| 3 | Unemployment (% labour fource)* | 4.0% | 4.0% | 3.5% | 3.4% |
| 4 | Government debt (% GDP)* | 53.9% | 57.1% | 107.8% | 110.0% |
| 5 | Current account balance (% GDP) | 0.6% | 0.2% | -2.8% | -2.7% |
| 6 | Fiscal balence (% GDP) | -4.2% | -3.8% | -4.4% | -4.3% |
| 7 | Central bank rate (%) a | 4.35% | 4.10% | 2.50% | 2.75% |
| 8 | Foreign exchange a | 6.7215% | 7.00% | 6.7215% | 7.00% |
Source: DWS and IMF Policy rates and FX rates are current March 11, 2019 to March 2020). All the forecasts are derived from reliable sources, they may prove to be inaccurate or incorrect and are subject to change at any time without notice.
Figure One shows eight critical metrics by which to gauge an economy, along with the relevant DWS forecast numbers for China and the U.S. in 2019 and 2020. For unemployment and government debt, I used International Money Fund (IMF) numbers given that we don’t have a firm forecast for these two series. Let’s go round by round and assign a winner.
Round One – Gross domestic product (GDP) Growth (%)
Not too controversial, I hope. Even with questions about headline data reliability it still seems likely that the Chinese economy enjoys a considerably higher headline growth rate than the more mature (veteran boxer?) that is the U.S. I give this round to China.
China 1, USA 0
Round Two – Consumer price index (CPI) Inflation (%)
A little closer to call, but given the expectation that the U.S. should soon be close to its 2% Inflation target, and China is still arguably overproducing to keep inflation below its stated 3% targeted inflation range, we have to give this one to America.
China 1, USA 1
Round Three – Unemployment (% Labor Force)
Unemployment profiles in both economies are looking very fit, with clearly not much room for excess fat in the labor markets to be trimmed. The nod of course has to go to the U.S. for a slightly lower level of unemployment, giving the capitalist bruiser an early lead.
China 1, USA 2
Round Four – Government debt (% GDP)
The headline numbers at the government level suggest that the Chinese government has far more fiscal punch, and China is awarded the round on that basis. Of course, the questions of state, local and consumer indebtedness remain, but, for now, the judges can only go by what they are seeing in the ring.
China 2, USA 2
Round Five – Current Account Balance (% GDP)
This was perhaps the toughest round to judge, and led to some serious economic hypothesizing amongst the judges. Should a nation ultimately care about its trade deficit? Does it not simply represent the aggregate decision-making of a number of well-informed and, presumably, utility-maximizing rational individuals in the U.S. who have carefully judged the price and quality trade off of goods and services, and concluded that the Chinese option (perhaps unknowingly to them) represents a better choice? Or can the over-consumption of foreign goods, at the expense of one’s home market lead down the road to ruin? Either way, my suggestion that one can obviously be less sure of a trade surplus or deficit as being definitively good or bad, was outvoted. Fair enough. Chalk another one up for China.
China 3, USA 2
Round Six – Fiscal Balance (% GDP)
A close call, and, subject to some of the same trade balance musings. Ultimately, we concluded that even if a fiscal deficit is being used for sensible purposes, spending a little less of what you earn makes sense (even if you’re still spending more than you earn!). China starts to stretch its lead. No showboating yet though.
China 4, USA 2
Round Seven – Central Bank Rate (%)
Our first tie. The argument that China’s higher policy rate gives it slightly more of an advantage to get off the ropes in the event of an economic downturn was neutralized by the lower real rates in the U.S. economy and that could provide much needed replenishment to a still vulnerable economy.
China 4 ½, USA 2 ½
Round Eight – Foreign Exchange
Our forecast for the yuan to depreciate a little against the US dollar over the course of the next year of course implies both winners and losers in both economies. However, in today’s context of trade wars we ultimately decided that most policymakers, if given a choice, would take a weakening currency that, amongst other things, could stoke a little domestic inflation, and provide some relief to a punch drunk export market.
Final Score: China 5 ½, USA 2 ½
Tongue in cheek though this whirlwind dust-up obviously was, our overarching point remains a serious one- that, like many emerging market economies, some of the headline numbers in China, while not perfect, remain the envy of many developed market policymakers.
Even if you disagree with the result, we hope you might at least be open to the notion that China continues to flex its impressive muscles in the global economy.
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