By Hayden Briscoe, Shamaila Khan and Jenny Zeng
China's economy isn't headed for a hard or soft landing - instead, it's more likely to be a long landing. That's our perspective, based on our team's recent visit to China to get an up-close look at the economic landscape.
The country's economy clearly faces another few years of uncertainty and negative headlines, but we think the risks will be contained as long as the government sticks to its reform agenda. On our China trip, we assessed conditions in important cyclical sectors, such as banking, basic industries and property.
Our takeaway: Investors who think the government's recent stimulus tweaks are a prelude to a more general nationwide stimulus - global financial crisis-style - are wide of the mark. In our view, the Chinese economy is actually in store for a long landing lasting two or three years. Commodity-related industries will face a painful readjustment, and some companies will default and may even collapse.
This scenario assumes that Chinese Premier Li Keqiang will stick to his structural reform agenda. We've said that policy risk is one of the biggest risks China faces: if the government were to abandon its reforms and revert to a broad stimulus, our view would turn negative. But we're still convinced - strengthened by the announced formation of a new anti-corruption body at last month's National People's Congress - that reforms remain on track.
Among the sectors we looked at in detail were banks and the property sector; the display below provides a quick summary of our views.
Banks: Getting Tough on Steel Mills
There are signs that China's large banks were more inclined to increase their property exposures in the first half of the year, as other sectors are facing headwinds that carry higher risks for them. Still, we regard short-term liquidity, not oversupply, as one of the two key risks for the property industry (government policy is the other). Banks said they were cautious about lending to developers; some have tightened their lending practices or are being selective, including concentrating on residential loans.
Banks are reducing their exposure to sectors burdened by overcapacity. For the first time, we heard that they weren't renewing loans to weak steel mills. This should lead to faster defaults and more consolidation, which would be positive for the sector in the medium term. We doubt, however, that smaller banks are reducing their lending to sectors with overcapacity. Doing this would create problems for the banks' own cash flows and balance sheets.
We saw differences in the way banks are managing their exposure to the shadow banking sector. One bank we spoke to had increased its exposure; in its view, recent announcements from the China Banking Regulatory Commission signaled an intent to regulate the sector, not slow it down. Another bank kept its exposure the same during the first half of the year compared with the previous corresponding period.
Property: Muddling Through
When we visited residential projects in the luxury and mass-market sectors, as well as some commercial projects, all in Changsha and Shanghai, we saw some distinctions. Overall sentiment is much more bearish in lower-tier cities than in "Tier 1" cities, even though Tier 1 cities have seen a bigger correction in sales volumes so far this year.
The companies we spoke to believe that underlying demand remains strong, and that supply and demand are much more balanced in Tier 1 cities, as shown in the display below, while inventories in lower-tier cities have been increasing, and de-stocking has been slow.
Most property developers remain reluctant to cut prices. They're hoping the government will eventually provide significant support for the market, despite the fact that developers who have cut prices by 10% in Tier 1 cities and 20% elsewhere have enjoyed good sales.
We believe the sector is unlikely to collapse, given the long-term prospects from trends such as continuing urbanization. We agree that the sector just needs time to consolidate and absorb the building surplus. Managers told us they expected the correction to last 18-24 months; sales should remain flat during 2015, but new construction should start rebounding year-over-year, helped by a low base in 2014.
These insights largely confirmed our view of the property sector. The only new information was that the government has started to allow certain developers to issue onshore medium-term notes. We consider the diversification of funding sources a positive for large developers.
In the second part of this blog, to be published soon, we'll look at prospects for the infrastructure and commodity sectors.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Hayden Briscoe is Director of Asia-Pacific Fixed Income, Shamaila Khan is a Portfolio Manager in Emerging Markets Corporate Bonds and Jenny Zeng is a Research Analyst in Corporate Credit, all at AllianceBernstein.