EMLD World Tour August 2021: China’s regulatory tightening

Invesco’s Global Debt Team publish monthly emerging marketing local debt (EMLD) outlooks and a spotlight on a new country each month, and below is their update for August. The team are based in New York and are part of the Invesco Fixed Income investment centre, known as IFI. To learn more about Invesco’s Global Debt Team, click on the link for your local website below.

We believe recent regulatory tightening in China is not inconsistent with the broader goals of the 14th five-year development plan to build the country into a modern socialist country.

Two main themes have emerged from these regulatory actions. The first is linked to network industries in firms such as Tencent, Alibaba and Didi, where a group’s control over consumer data is viewed as promoting monopolistic trends, as seen in other countries in companies like Amazon, Facebook and Uber.

There is less tolerance for this risk in China, where increasing income inequality remains top of mind as a potential source of discontent and could potentially undermine the legitimacy of the country’s social contract. In China, there is additional concern that power over data could undermine the absolute power of the Communist Party.

The second theme is related to the “three mountains” of education, housing and health. These ongoing challenges have been highlighted before and affect the livelihood of China’s people and long-term trends, such as population growth. These could undermine China’s potential growth going forward.

Nevertheless, we have not seen significant tightening in the health sector, though it is possible that the Covid-19 pandemic may have spared that sector for now.

We think recent regulatory moves are not arbitrary, but instead reflect these specific thematic concerns. Additionally, we do not believe these risks signal a change in China’s policy, which relaxed investment restrictions to allow for greater foreign access to fixed income.

Nonetheless, we are mindful that the intensity of the regulatory tightening has raised concerns about investing in China. Overall, the moves do not affect our general views on China exposure, though we favour sovereign interest rates over the currency. 

What’s next in emerging market debt?

We believe global growth remains supportive of emerging markets, as the Delta variant will likely not prevent countries from re-opening and global growth data improved in June and July, despite China’s slowdown. Prices of commodities and their derivatives remain strong.

US financial conditions are still supportive of emerging markets, with long-term US real rates solidly in negative territory.

Opportunities remain compelling

Going forward, range-bound US interest rates will catalyse positive performance in emerging market rates, providing potential capital gains in the asset class over the balance of the year (Figure 1). 

We believe an even larger medium-term opportunity exists on the currency side, not necessarily against the US dollar initially, but versus a basket of alternative funding currencies.

Capital appreciation and income generation opportunities in emerging market local currency debt will continue to be compelling on an absolute and relative value basis.