Challenges within the U.S. for Trump (i.e. risks of an impeachment, growing calls by U.S. corporates to de-escalate the trade war, etc.) might bias the Trump administration towards a multi-phased trade deal with China, rather than striving for a lower probability “big deal”. As such, there is now a higher possibility for a piecemeal multi-phased de-escalation of the trade war (although it still appears unlikely that some key U.S. demands will be met).
While tariffs are detrimental, the overall impact is still manageable for China. Note that U.S. demand comprises no more than 5% of China’s total industrial output, with the remaining 95% comprised of domestic demand (70%) and exports to other countries (25%), which are not directly affected by U.S. tariffs. In addition, depreciation of the RMB is a relatively efficient tool for China to mitigate the effects of the tariffs, as a 10% depreciation of the RMB would boost exports by an estimated 6% points, which translates into about an 80 bp increase in China’s GDP. Whereas, the corresponding negative impact on China’s inflation would only be a 20-30bp increase in CPI inflation, as most goods consumed in China are produced in China itself. Furthermore, the vast majority of Chinese corporate debt is in local currency rather than hard currency, and thus a depreciation of the RMB should only increase FX liabilities by a relatively small amount. As such, we note that outside of policy and monetary tools, the way China’s economy is set up, puts it in a favourable position to weather a prolonged trade war with the US.
With regards to the China property sector, the year-to-date contracted sales as of end Sep 2019 rose 17% y/y for the major developers (with the month of Sep registering a +29% y/y growth), showing that the residential property market remains robust. China HY property developers, which comprise a large share of Asia HY corporates, have seen more positive than negative rating actions in recent months. We expect most Chinese property developers to experience improving credit metrics over the next year, as revenue is set to outpace debt growth - strong contracted sales growth for many developers over the past 2-3 years is expected to drive revenue growth in 2019-2020, while more conservative contracted sales growth targets (starting in 2019) will reduce the need for debt-funded land purchases.
The US-China trade negotiations could drag over into 2020 despite some recent goodwill gestures by both sides, in addition, we expect global growth to continue to decelerate. As such, we remain relatively defensively positioned by being biased towards higher quality credits and shorter duration. Having said that, we expect default rates to remain manageable, as credit fundamentals are sound, and the slowdown in global growth is expected to be gradual.
Diamond Capital Management (Switzerland) Ltd.
Angsana Asia HY Bond Fund - September 2019 update