Market thinking

Playing the long game in China: three reasons not to panic over regulatory changes

Treading a path to tighter controls

To say China’s recent crackdown on technology and private education caught markets off guard is an understatement.

Yet the shift in policy seems to be a sign of things to come. It reflects an evolving stance – outlined in a five-year plan1 in mid-August 2021 – where Beijing will tighten regulatory control in relation to areas such as national security, the digital economy and healthcare.

Amid confusion and uncertainty from sweeping changes to date to the seemingly long-term government-led strategy of building a high-tech, knowledge-based economy, foreign investors have collectively lost tens of billions of US dollars as valuations of many companies in the affected sectors have plummeted.

Since the historic suspension of Ant Group’s IPO in November 2020, there have been some casualties among some of the leading technology players. The recent spotlight then shifted to online private tutoring with some abrupt reforms causing financial pain to market leaders.

Risking spill-over

The impact will potentially spread beyond investor sentiment. Taking education, for example, while the sector’s contribution to economic growth is relatively minimal, at around 0.7% of 2019 GDP in total market cap2, there is a risk of market spill-over due to broader uncertainty.

More significant is the impact of a dampened role for big tech going forward. Given its role in advancing innovation domestically and attracting global capital, Beijing needs to find a way to balance fair competition yet preserve the vitality of these companies, as well as investor appetite in them.

Ultimately, this requires reforms – and the communication of them – that indicate a more measured path with greater transparency.

Staying focused on China’s future

A policy landscape in flux makes it difficult to pinpoint an end-game with any accuracy. However, investors should look beyond Beijing’s recent actions. In particular, we see three clear reasons to stay invested in China’s longer-term vision.

1.The policy shift indicates the underlying priority of China’s long-term economic and social development.

The constraints on technology and education that took investors by surprise can also be viewed as initiatives that support planned efforts to reduce inequality in the country.

This aligns with the mantra of “common prosperity”, which is in sync with the 19th Party Congress and recent 14th Five Year Plan in pursuit of the government’s strategic goals.

In short, these prioritise social equality and well-being. They can be achieved, believes Beijing, by determined short-term policies that are expected to be seen as positive in the longer term.

For example, ensuring better-quality compulsory education would prevent the situation where parents are forced to resort to private tutoring which, in turn, creates inequalities.

2.The restrictions on tech and education are aimed at levelling the playing field by correcting comparatively less stringent antitrust regulations.

China’s regulatory environment within the internet space has been evolving, and recent concerns around cybersecurity are inevitable following the accelerated pace of digital adoption due to Covid-19.

While data protection regulations in China have been around for over two decades, the recently passed Data Security Law and soon-to-be-passed Personal Information Protection Law will help to aggregate various policies and provide clarity over companies’ responsibilities.

At the same time, the country’s antitrust regulations are less stringent than those in the US and EU. Beijing can therefore be considered as simply catching up in scrutinising internet giants that have grown rapidly.

The potential upshot of imposing limitations on sectors of strategic interest might be to make future investments be more productive. The rationale is that they become more targeted and efficient, such as by allocating more resources to research and development instead of marketing for more traffic growth.

This will come amid greater opportunities going forward for competition in the sector, according to Fitch Ratings3.

Further, striving for enhanced service and innovation – rather than destructive competition or abusing market positions – bodes well for companies in segments that support Beijing’s bigger-picture vision for tech self-dependency: artificial intelligence, semiconductors, 5G, robotics, advanced manufacturing and clean energy.

3.Policymaking in China rarely follows a direct path, and adapting to Beijing’s perspective may help foreign investors focus on the long-term game.

More recent rhetoric from China should make it clear to all investors that the country’s economic outlook is about balancing short-term stability and long-term sustainability.

In fact, the strong cyclical rebound in the economy since mid-2020 can be seen as offering policymakers a window of opportunity to press ahead with structural changes.

As a result, recent events don’t change our overall positive sentiment and investment approach to China; we expect the regulatory landscape to shift and mature along with the economy. This is even clearer amid China’s stated objective of achieving quality and sustainable growth.

In our view, the government is basically saying: “You can continue to grow, but do not put our national security at risk”.

Rebooting investor confidence

For the time being, investor sentiment overall will likely remain bearish until there is a clearer or more predictable framework for strategic sectors. Yet care must be taken not to misinterpret policies, or over-react to them.

It also helps to follow a bottom-up, stock-driven process, rather than a top-down allocation.

Longer term, as the government gets better at communicating its policies and the various pieces come together to form a clearer picture, investor confidence should improve. Regulatory risk in China is not new but we believe it must be weighed against the superior growth opportunities that still exist.