By Nicholas Yeo, head of China equities at abrdn

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China’s top legislative body, the standing committee of the National People’s Congress, announced In November debt swap programs after its 4-day meeting. The plan involves swapping up to 10 trillion yuan ($1.4 trillion) of off-balance sheet, or ‘hidden’, local government debt over five years. While the lack of a meaningful stimulus package left some investors disappointed, the move was still largely anticipated, resulting in minimal swings in the market.

What does this debt swap mean?

The debt swap would help cut interest payments for local governments and encourage more borrowing. Some sell-side brokers estimate it could save RMB600 billion in interest over five years. This will enable local governments to pay salaries and invest in economic development without resorting to fire sales of assets or squeezing corporations with penalties and back taxes just to discharge their debt obligations. Importantly, this swap does not represent any incremental borrowing, therefore it is not counted as stimulus.

No consumption stimulus?

In our view, reducing the debt burden for local governments is crucial to prevent them from seeking income from various sources to meet their payment obligations, which would otherwise hinder development and consumer wellbeing. Direct policies to boost consumption and support for the property sector would likely be delayed to the Central Economic Work Conference in December or the “Two Sessions” in March, referring to the concurrent annual meetings of the National Committee of the Chinese People’s Political Consultative Conference (CPPCC) and the National People’s Congress (NPC). This timeline would allow the central government to gauge the impact of Trump’s first 100 days in office, particularly regarding tariffs. We anticipate more fiscal support and structural reforms to come through in 2025, as failing to provide additional stimulus could harm China’s policy credibility and risk a deflationary loop.

Trump and China

Under a Trump presidency, China is likely to face higher tariffs, increasing pressure on its exports.  However, Trump’s victory might push the Chinese government to boost domestic growth with more aggressive stimulus measures. At this point, many of Trump’s controversial campaign promises, such as imposing more tariffs on all Chinese exports to the US, or mass deportations of undocumented immigrants may not materialise in their current form due to potentially large negative impacts on the US economy. With a more transactional US President in Trump, a mutually beneficial agreement between the US and China is possible.

History suggests that the ‘Trump bad for China’ narrative isn’t necessarily enough to drive equity returns in the long run. In fact, we see domestic issues as the most important driver of Chinese equities.

Source: Bloomberg, 11 Nov 2024

As seen in the chart above, following the initial impact of the first trade war in 2018, Chinese markets rallied from the end of 2018 to the middle of 2021. In 2021, several domestic issues impacted the market, including: radical COVID policies, a regulatory crack down and property deleveraging. The direct impact of tariff’s was relatively short lived. Further, following the first Trump Presidency Chinese companies have developed various alternative trade routes and fostered new destinations for their goods. More recently, in late-September, the market rallied on hopes of a domestic revival.

On a positive note, earnings per share (EPS) growth have been relatively better than expected in the third quarter, despite Q3 being a seasonally weak quarter. Internet companies, in particular, appear to be doing well, as reflected in the MSCI China Index outperforming the onshore-focused CSI 300. That said, CSI 300 EPS could prove to be better resilient in Trump’s tariff world, given that it is more domestic driven with localisation benefits across our five investment themes – digitalisation, health, wealth, consumption, and renewables. October also saw some green shoots in real estate, with primary and secondary property transaction in Tier-1 cities such as Beijing and Shenzhen exceeding expectations.

We remain cautiously optimistic about the outlook this time around. Chinese equities are attractively valued, have lower correlation to global macro trends, and benefit from strong domestic policy tailwinds. Any major pullback in the market due to US tariff uncertainties would be a good time to add to China as we believe there is scope for idiosyncratic positive returns versus other markets, considering Chinese equities are trading cheap compared to history and against peers. Moreover, low positioning further enhances the potential scope for a prolonged re-rating.