China is no longer just an emerging market

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

Kevin Frayer | Getty Images News | Getty Images

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

China is showing greater caution this year as strict Covid controls drag on and growth takes a back seat. Analysts note longer-term trends of China’s reduced reliance on foreign investment and intellectual property.

This all comes on top of Beijing’s crackdown on the internet tech industry and property developers over the past two years.

Foreign investors react. The share of Chinese stocks in the MSCI Emerging Markets Benchmark fell from a peak of 43.2% in October 2020 to 32% in July 2022, Morgan Stanley analysts pointed out.

In the meantime, exchange-traded funds that track emerging markets — but not China — saw their assets under management grow from $247 million at the end of 2020 to $2.85 billion in July 2022, according to the report.

WisdomTree last month became the latest company to launch a fund for emerging markets outside China, following Goldman Sachs earlier in the year.

This mood has shifted from China being 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 substantial element of risk

Ketan Patel

co-founder and CEO of Greater Pacific Capital

“We certainly hear from customers [saying]perhaps given the current political environment, perhaps composing[ing] down in China might be a better strategy,” said Liqian Ren, head of quantitative investments at WisdomTree.

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

The category includes Brazil and South Korea and refers to economies with generally faster growth than developed economies such as the United States – and more risk.

Rivalry with the United States

But what Ren and others say is different for China now is that the United States has singled it out as a strategic competitor. More recently, the Biden administration has continued limited China’s ability to use American technology to develop advanced semiconductors.

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

People aren’t going to ignore China, “but the level of excitement has changed,” said Patel, former head of Goldman Sachs’ strategy group.

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

Beijing also presents itself as a great power.

Chinese President Xi Jinping has pushed the country not just to be self-sufficient in technology and energy, but to lead other nations with alternative — if not competing — systems for finance, navigation and international relations. These include a global development initiative and a global security initiative.

In China, the government under Xi has increased its role in the economy.

The share of state-owned enterprises in China’s top 10 enterprises increased by 3.6 percentage points between 2020 and 2021, despite an overall decline of 10 percentage points over the past decade, said Rhodium Group. In total, the report says these SOEs make up more than 40% of the top 10 – well above the open economy average of 2%.

“Nor can we 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 Office Rules

The growing role of the Chinese Communist Party under Xi is now a bigger concern 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, law enforcement did not begin to resume until after 2012, according to the Center for Strategic and International Studies.

An internal party committee, or bureau, brings together employees of a company who are members of the Chinese Communist Party. They can then organize events such as the study of “Xi thought”.

New rules from the China Securities Regulatory Commission that took effect in June indicate that securities investment funds in China need to set up an internal party office.

Asked about the new rules, the securities regulator said they were in line with corporate governance principles and Chinese law, and there was “no need to worry at all” about data security, according to a CNBC translation from Chinese.

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It is unclear what role these party offices play in business operations, Daniel Celeghin said earlier this year when he was managing partner at consultancy Indefi.

But before the pandemic, he said, at least one major Western asset manager decided against setting up a subsidiary in China because once he learned there would be a need to set up a party cell , “it outweighed any potential trading gains”.

China’s call

Funds such as a few from WisdomTree offer ways to invest in emerging markets without investing investors’ money in public companies.

In China, the market capitalization of non-public companies has fallen to around 47% from 35% a decade ago, according to Louis Luo, director of multi-asset investments at Abrn.

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

Even with slower growth, China’s future attractiveness may lie in simply offering an alternative to investing in other countries.

Global markets have been rocked this year by attempts by the US Federal Reserve and other central banks to rein in inflation by aggressively raising interest rates. But the People’s Bank of China is going in the opposite direction.

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

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