EM Monthly: Have China’s policymakers done enough?

March 21, 2024

In the first of a new series, portfolio managers Warren Hyland and Mel Siew scan the emerging market universe to pick the stories investors need to know.

The Big Story: Where does China go from here?

For investors in emerging markets, events in China are often top of mind. And, based on our meetings with Australian clients in the past week, that is very much the case now. Many commentators viewed China’s economic performance last year as underwhelming, despite policymakers finally easing the restrictions put in place during the pandemic. Since last October, however, policymakers have aggressively loosened policy through fiscal stimulus, monetary expansion, targeted banking sector measures and local government regulation.

The question on the minds of our Australian and many other clients is: Have they done enough?

Recap: How is China stimulating growth?

In February, the People’s Bank of China (PBoC) cut the bank reserve requirement ratio (RRR) by 50 basis points (bps), releasing the equivalent of CNY1 trillion (US$140 billion) into the banking system. PBoC Governor Pan Gongsheng personally announced the move, highlighting that boosting near-term sentiment and confidence in the country's economic outlook is a Communist Party priority.

This was followed by a surprise cut in the key reference rate for home mortgages - the five-year loan prime rate – from 4.20% to 3.95%. This was the largest one-time adjustment since its introduction in 2019. Looking ahead, if we assume RRR cuts total 100bps and policy rates 30bps, monetary easing could boost growth by up to 1.3% in 2024.

Fiscal stimulus, meanwhile, is expected to come from the upward revision to last October’s budget, from 3% to 3.8%.  And, in early March, the government announced a further CNY1 trillion of issuance through a special ultra-long sovereign bond, complimented by the PBoC’s CNY1 trillion of pledged supplementary lending - China’s version of quantitative easing. In aggregate, China will increase fiscal expansion by between 1.5% and 2% of GDP.

It is optimistic to suggest policy stimulus will have a straight pass-through to economic growth when considering lags on implementation, the multiplier effect and how people react in a deflationary environment. A more conservative approach would be to take the National People’s Congress 2024 growth target, which is around 5%. Even then, that number is seen as ambitious by some commentators in the face of ongoing challenges in the property market, falling wages, sluggish domestic consumption and high youth unemployment.¹

What’s next?

The focus and effort on boosting growth highlights China’s determination to reverse economic decline. But will this be enough to turn sentiment? The key variables to monitor will be money and credit growth, which will indicate whether stimulus has filtered through to the economy. Housing data, a sector at the core of China’s problems over the last two years, is another powerful indicator. 

Looking at our own proprietary China macro model, to-date we can conclude robust policy stimulus has effectively stabilised the economy. But we have yet to see any lift off (see Fig. 1).

China Policy Effect – Stabilisation but no lift off yet

A Z-score indicates how many standard deviations a data point is away from the mean of a dataset; a positive score means the number is above average, a negative score below average. Measuring Z-scores facilitate comparisons and understanding of a score’s relative position within the distribution.

The below chart is based on publicly available Chinese economic data on the property sector, credit (such as money supply), market sentiment, inflation and consumption.

Fig. 1 - Weighted Z-score

Source: Muzinich internal analysis, as of 31st December 2023. Latest data available used. For illustrative purposes only. 

The Month in Credit: Sovereign yields and compression dominate

The main drivers in credit markets for February were rising government bond yields and continued compression, with more speculative names outperforming as investors hunted for value.

Emerging markets outperformed developed markets in investment grade and high yield. Stable fundamentals combined with supportive central banks, a lack of supply and underweight positioning from global investors helped push a strong technical bid. Additionally, the search for value brought buyers back into the secondary market.²

Sovereigns slightly outperformed corporates due to a strong rally in distressed debt, including Egypt, Ecuador and Ukraine. Within the corporate universe, the short-duration index outperformed the broader market as rising sovereign yields worked against longer-dated securities. High yield generated a strong positive total return, with Asian high yield and single-B names outperforming.

Autos and financials outperform

In investment grade, EMEA had the smallest drawdown, with the outperformance of Eastern Europe’s property sector helping cushion the impact of rising rates. At the sector level, autos and diversified financials outperformed on a risk-adjusted basis; for total returns, property generated a positive return while utilities and telecoms, which are more sensitive to interest rates, saw the biggest drawdowns.

Emerging-market issuance totalled US$30.1 billion, which left net financing for February at $3.6 billion. The Middle East and Africa was the heaviest source of supply at 40%. At a sector level, financials accounted for 58%, while the split between IG and HY supply was 77% and 23%. Meanwhile, green, sustainable and social bonds accounted for US$5.9 billion.³

In terms of ratings, there were 23 downgrades and 16 upgrades - 60% of downgrades were high-yield adjustments, while Asian credits represented 56% of upgrades.⁴

Past performance is not a reliable indicator of current or future results.

The Main Events: Easy does it for Peru, Czechia and Hungary

Whilst the question of when central banks will cut rates dominates headlines in developed markets, some of their EM counterparts are already on that path. In Latin America, Peru cut policy rates by 25bps for the fifth successive month; in Eastern Europe, Czechia and Hungary reduced policy rates by 50bps and 100bps respectively.⁵ Elsewhere, Mexico’s central bank opened the door for cuts to begin in March.

The story for EM central banks is not just one of easing, however. Turkey’s central bank left policy rates unchanged at 45% and offered hawkish guidance against the upside risk to inflation. Meanwhile, its Nigerian counterpart surprised the market by significantly tightening policy rates by 400bps to 22.75% and adjusting its cash reserve ratio to 45% from 32.5%. This is a strong signal the central bank is serious about regaining investor confidence, stabilising the Naira and anchoring inflation expectations.⁶

In South Africa’s much-anticipated 2024 budget, minister of finance Enoch Gondongwana sought to appeal to both sides of the political spectrum - those arguing for faster fiscal consolidation and those wanting to address the country’s sub-par growth. This year’s consolidated budget remained unchanged at 4.9% of GDP compared to the consensus of 5.3%; next year, the deficit will now narrow to 4.5% and 3.3% by 2026. The Treasury remains committed to running a primary surplus and stabilising debt within its medium-term expenditure framework, with debt-to-GDP peaking in 2026 at 75.3%.⁷

Mexico’s state-owned energy giant Pemex was double downgraded by Moody’s, with the agency questioning the government’s willingness to financially support the company. The government forcefully responded by disclosing Pemex will be exempt from paying hydrocarbon duties for four months from Q4, which we believe should free up around US$3 billion in cash.

ADQ to the rescue?

In the Middle East, the United Arab Emirates agreed to invest $35 billion in Egypt. ADQ (the sovereign wealth fund formerly known as the Abu Dhabi Developmental Holding Company) will acquire development rights for the Ras-el-Hekma region on Egypt’s northern Mediterranean coast for US$24 billion, with a further US$11 billion of investment earmarked for “prime projects across Egypt to support its economic growth and development”.⁸

A US$15 billion payment will be made immediately with the remainder expected in the next two months. The initiative could generate up to US$150 billion in future capital inflows. This significantly reduces Egypt’s external financing challenges in the short term, with the country’s debt rallying strongly on the news.⁹

In Indonesia, the country’s former defence minister Prabowo Subianto was elected president. His victory signals continuity rather than any significant change in policy and governance. Prabowo is likely to be more engaged in foreign policy but avoid taking sides in the expanding geopolitical contest between China and the West. He may, however, be more protective over Indonesia’s territory, which could result in more friction with China.

References to specific companies is for illustrative purposes only and does not reflect the holdings of any specific past or current portfolio or account.

On the Lookout: What to watch out for in March

• The Election Commission of India should confirm the calendar of the general election. The month-long polling period is tentatively scheduled to start on April 16.
• In Argentina, Congress reconvenes for regular sessions on March 1. President Javier Milei needs a strategy to implement the reforms he proposed through the abandoned omnibus bill.
• While Mexico’s central bank held its benchmark rate at 11.25% for a seventh consecutive meeting in February, March is expected to see it begin the process of cutting rates.
• Egypt is expected to sign a staff-level agreement with the International Monetary Fund. This will detail the key elements of economic reforms required to secure further financial support from the IMF, estimated to be worth US$8-10 billion.
• While not strictly an emerging-market story, the Bank of Japan’s policy meeting on March 18-19 could have a significant impact on global markets should it see the end of negative interest rates, in place since January 2016. Much hinges on whether wage growth accelerates. However, in our view, March might not be the right timing for the first hike in 17 years; the central bank has no reason to rush in the absence of high inflationary pressures.

Source: Muzinich & co as of March 2024. For illustrative purposes only.

Credit

Yield to Worst

Past performance is not a reliable indicator of current or future results

Source: ICE data platform. as of 29th February 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, ADOL - ICE BofA Asian Dollar Index, ADIG - ICE BofA Asian Dollar High Grade Index, ADHY - ICE BofA Asian Dollar High Yield Index, EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,.Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only.

Referrences

1 and 2: Bloomberg News, China’s Bullish 5% Growth Goal Seen as ‘Target Without a Plan’, March 5, 2024
3: JP Morgan EM Corporate Supply technicals, February 2024
4: JP Morgan EM Corporate Weekly Monitors as of 5th February, 12th February, 27th February, 5th March 2024
5 and 6: Bloomberg, CBRT, as of 29th February 2024
7: Department of National Treasury, Republic of South Africa Budget Review, as of 21st February 2024
8: ADQ, as of 23rd February 2024
9: Business Today Egypt, as of 23rd February 2024

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of March 2024 and may change without notice.

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Index Descriptions

EMGB - ICE BofA Emerging Markets External Sovereign Index tracks the performance of US dollar and euro denominated emerging markets sovereign debt publicly issued in the major domestic and eurobond markets.  Qualifying securities must have risk exposure to countries other than members of the FX-G10, all Western European countries and territories of the US and Western European countries.

EMCB - ICE BofA Emerging Markets Corporate Plus Index tracks the performance of the US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets. Qualifying issuers must have risk exposure to countries other than members of the FX G10, all Western European countries, and territories of the US and Western European countries.

EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated AAA through BBB3, inclusive.

EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated BB1 or lower.

Q690 - ICE BofA Custom Emerging Markets Short Duration Index tracks the performance of short-term US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

ADOL - ICE BofA Asian Dollar Index tracks the performance of U.S. dollar denominated sovereign, quasi-government, corporate, securitized and collateralized debt publicly issued in the U.S. domestic and eurobond markets by Asian issuers.

ADIG - ICE BofA Asian Dollar High Grade Index tracks the performance of investment grade U.S. dollar denominated sovereign, quasi-government, corporate, securitized and collateralized debt publicly issued in the U.S. domestic and eurobond markets by Asian issuers. Qualifying securities have a country of risk classified as an Emerging Markets country that is part of the Asia/Pacific Region.

ADHY - ICE BofA Asian Dollar High Yield Index tracks the performance of sub-investment grade U.S. dollar denominated sovereign, quasi-government, corporate, securitized and collateralized debt publicly issued in the U.S. domestic and eurobond markets by Asian issuers.

EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Latin America.

EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Latin America region.

EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated sub-investment grade based on the average of Moody's, S&P and Fitch, and with a country of risk associated with the geographical region of Latin America.

EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Europe, the Middle East and Africa including Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan.

EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

Index performance is for illustrative purposes only. You cannot invest directly in the index.

Important Information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.

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