Citi PB: Reforms to boost China’s old economy in 2018

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Chinese banks, seen as risky by many investors, are looking attractive in 2018 due to ongoing reforms, said Ken Peng, Citi Private Bank investment strategist for Asia-Pacific, who also likes China’s industrial sector.

Citi PB: Reforms to boost China's old economy in 2018

Peng said the situation with distressed loans held by Chinese banks is improving due to tightening regulations.

In the past decade, the top challenges in the Chinese banking sector were leveraged balance sheets, a high level of bad debt and lending by China’s shadow banks, which are unregulated. Although some of these issues still remain today, the government’s pledge to lower the leverage of the banking sector is expected to bring down risk across the sector, he noted.

“We are not saying that these issues will be corrected completely overnight. But we see the reforms paving the way for the banks to be in a healthier situation,” he added.

As balance sheets improve, stock prices of the banks should rise, as many are currently trading under book value.

We see the reforms paving the way for the banks to be in a healthier situation

Another structural reform in China aims to consolidate capacity in the industrial sector to ramp up prices, boost productivity and support economic growth.

After two years of a consolidation, producers of steel, cement and coal, and property developers are benefiting from more competitive prices and a more efficient market, Peng said.

Moreover, after the consolidation, only strong players are likely to remain dominant, supporting sector growth, he added.

Hong Kong surge?

Key events expected to unfold in 2018 in Hong Kong and China have created market opportunities, Peng said.

The Hong Kong Stock Exchange in December concluded a consultation paper which, if enacted, promises key listing changes. The reform is set to revamp rules so that companies with weighted voting rights are eligible (which Alibaba wanted but was refused, sending it to the US to list). Additionally, biotech companies that want to list would be exempt from the requirement of three years of profitability.

Peng said the change of rules, if enacted, would attract large-cap tech firms in China to list in Hong Kong, which would help cement the SAR’s role as an international financial hub across Asia. They would also attract foreign capital and drive the performance of the Hong Kong market in 2018. Therefore, he is bullish on brokers and other companies linked to securities trading in Hong Kong.

China’s onshore market should see a boost as well. A-shares will be included in the widely-tracked MSCI emerging market index and Peng expects the inclusion to result in foreign capital inflows.

“Investors may start allocating into China’s onshore equity market before the inclusion to capture the upside of A-shares,” he noted.

“The initial stage of the inclusion will add 222 stocks of onshore China companies into the MSCI emerging market index. It will account for only 0.08% of the index composites, which is far below the 11% of A-share market capitalisation in the global equity market,” he said.

He expects the index provider will continuously lift the ratio after the primary inclusion, under the condition that the A-share market remains relatively stable over the next two years.

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