China is no longer just any emerging market

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We have revised our forecast for China's growth downwards again, says the IMF

A worker disinfects the Sanlitun shopping complex in Beijing in June as shops in the area were closed for three days following a Covid outbreak. China is more cautious this year as tight Covid controls drag on and growth takes a back seat. Analysts note longer-term trends of China’s less reliance on foreign investment and intellectual property.

Kevin Frayer | News from Getty Images | Getty Images

BEIJING – China is no longer just another emerging market segment. Now the country becomes its own animal – with all the risks and rewards that come with being a world power.

China is more cautious this year as tight Covid controls drag on and growth takes a back seat. Analysts note longer-term trends of China’s less reliance on foreign investment and intellectual property.

It all comes on top of Beijing’s crackdown on the internet tech sector and real estate developers over the past two years.

Foreign investors react. The proportion of Chinese equities in the benchmark MSCI Emerging Markets Index fell to 32% in July 2022 from a peak of 43.2% in October 2020, analysts at Morgan Stanley pointed out.

Meanwhile, exchange-traded funds tracking emerging markets — but not China — recorded assets under management from $247 million at the end of 2020 to $2.85 billion in July 2022, the report said.

WisdomTree last month became the latest company to launch an emerging markets ex-China fund, following Goldman Sachs earlier in the year.

That sentiment has shifted from China as one of the most attractive places to invest in the world…to the fact that the rivalry [with the U.S.] introduced an element of uncertainty and a fairly significant element of risk

Sticky Rice

Co-founder and CEO of Greater Pacific Capital

“We definitely listen to customers [saying]maybe given the current political environment, maybe choose[ing] Shutting down China might be a better strategy,” said Liqian Ren, head of quantitative investing at WisdomTree.

So far, she said, excluding China, the number of customers is not “stunning” and the country remains an emerging market when measured by metrics such as GDP per capita.

The category includes Brazil and South Korea and refers to economies that are generally growing faster than developed economies like the US – and are at higher risk.

rivalry with the United States

But what Ren and others say differently for China now is that the US has designated it a strategic competitor. Most recently, the Biden government further restricted China’s ability to use US technology to develop advanced semiconductors.

“That sentiment has shifted from China as one of the most attractive places to invest in the world and how much certainty was perceived in politics, to the fact that the rivalry [with the U.S.] introduced an element of uncertainty and a fairly significant element of risk,” said Ketan Patel, co-founder and CEO of Greater Pacific Capital, last month.

People won’t ignore China, “but the excitement has changed,” said Patel, a former head of Goldman Sachs’ Strategic Group.

And rather than seeing China as a developing country — which it is, especially in rural areas — foreign investors would see it more “as a great-power opportunity,” Patel said. He also leads the Force for Good initiative, which promotes investment as a means to achieve sustainable development worldwide.

Beijing is also presenting itself as a great power.

Chinese President Xi Jinping has urged the country not only to be self-sufficient in technology and energy, but to lead other nations with alternative – if not competing – systems of finance, navigation and international relations. These include a Global Development Initiative and a Global Security Initiative.

Within China, the government under Xi has expanded its role in the economy.

According to a report by the Atlantic Council and Rhodium Group, the share of state-owned companies in China’s top 10 companies increased by 3.6 percentage points between 2020 and 2021, despite an overall decline of 10 percentage points over the past decade. Overall, the report says these state-owned companies make up more than 40% of the top 10 — well above the open economy’s average of 2%.

“We also cannot accurately measure informal barriers to market competition — for example, informal discrimination against foreign and private companies, industrial policies, or the presence of Communist Party committees,” the report said.

New party rules

The growing role of the Chinese Communist Party under Xi is now a bigger problem for finance – an industry in which China has recently allowed more foreign ownership.

Chinese law has long required internal party committees – for companies with at least three party members. However, enforcement only started after 2012, according to the Center for Strategic and International Studies.

An internal party committee or bureau gathers a company’s employees who are members of the Chinese Communist Party. They can then hold events such as the study of “Xi Thought.”

New rules from China’s securities regulator, which came into effect in June, require securities funds in China to set up an internal party bureau.

When asked about the new rules, the securities regulator said they are in line with corporate governance principles and Chinese law, and according to a CNBC translation of Chinese, there is “no need to worry at all” about data security.

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What role such party offices play in business operations is unclear, Daniel Celeghin said earlier this year when he was managing partner of consulting firm Indefi.

But before the pandemic, he said, at least one major Western wealth manager decided not to set up a subsidiary in China because once they learned the need to set up a party cell “that overcame any potential commercial gains.”

China’s allure

Funds like some from WisdomTree offer ways to invest in emerging markets without putting investors’ money in state-owned companies.

In China, the market capitalization of non-sovereign companies has increased to about 47% from 35% a decade ago, according to Louis Luo, investment director of multi-asset at Abrdn.

The upcoming Chinese Communist Party convention will be more of a “confirmation of what is already in place,” Luo said, adding that he expects a return of some more pro-market policies. Sectors he’s betting on for the long term include consumer goods, green tech and wealth management.

Even with slower growth, China’s future appeal may lie in offering only one alternative to investing in other countries.

Global markets have been rattled this year by attempts by the US Federal Reserve and other central banks to curb inflation through aggressive interest rate hikes. But the People’s Bank of China is going in the opposite direction.

A fundamental difference between emerging and developed markets is how independently they can set their monetary policy from the United States, Luo said. “From this point of view, I think China is standing up.”