Paul O'Connor:

Good morning all, and welcome to the Netwealth Portfolio Construction Podcast series. My name is Paul O'Connor and I'm the head of strategy and development for the investment options offered by Netwealth. Today, we are fortunate to have Chi Lo from BNP Paribas Asset Management, who is the senior market strategist for the Asia Pacific region and is based in Hong Kong. Good morning, Chi and thank you for participating in today's podcast.

Chi Lo:

Good morning, Paul. Pleasure is all mine. Thank you.

Paul O'Connor:

Chi has been with BNP Paribas Asset Management since 2010 and prior to joining, was head of overseas investment at Ping An of China Asset Management. Chi's other positions in Asia include Asia research head for the British Private Property Fund, Grosvenor, chief economist and strategist for Asia at Standard Chartered Bank and research director for Greater China at HSBC in Hong Kong. Before working in Asia, Chi was an economic advisor to the Canadian Treasury.

His other experience includes with international research firms in North America, regulatory bodies in Toronto and London and international investment banks in North America, England, and Asia. He was listed on the international who's Who of professionals in both 2000 and 2011 and has many years of research experience in economics and financial market. Chi's also the author of 13 books on Chinese and Asian economic development and markets. He has published research work in international journals and newspapers and appeared as a speaker at international seminars such as at the United Nations, the World Economic Forum, Asian Development Bank, World Bank, House of Lords of the British Parliament, the European Commission, and other central bank conferences. Chi's latest book is the Digital Renminbi's Disruption released in 2022. He's taught economics and finance courses at various universities in Hong Kong, and Chi studied economics at the London School of Economics and Political Science in England and the University of British Columbia in Canada.

He's imminently qualified and experienced to talk to us today about the Chinese economy and market. BNP Paribas Asset Management is the investment management arm of BNP Paribas SA and manage about 501 billion Euro dollars as at the end of 2020 across a range of active passive and quantitative investment solutions covering a broad spectrum of asset classes and regions. BNP Paribas employ over 500 investment professionals. The Netwealth Super and IDPS investment menus include four BNP funds, including the BNP Paribas C WorldWide Global Equity Trust, BNP Paribas EARTH Trust, BNP Paribas China Equity Trust, and BNP Paribas Green Bond Trust. The China's economy is a significant focus of economists and investment professionals alike, due to the growing impact it has on global GDP and trade. Since 2000, the Chinese economy has been growing well in excess of 6% per annum, whereas the US economy's average growth rate has been less than 2%, and Australia's has been about 2%.

However, since the COVID induced slowdown, the China's economy growth has slowed to 2.2% in 2020 before rebounding in 2021 to a strong 8.5%. However, in 2022 moderated again back to about 3%, which is roughly about half of the growth rate of the economy over the last 20 years. So why does this matter? Well, the Chinese's economy is now about 20% of global GDP and is also Australia's largest trading partner, accounting for nearly one third of our trade with the world. If China slows, the Australian economy will also slow. This relationship inextricably links the two countries, given the Chinese need to import many Australian hard commodities to continue their economic development.

Rising political tensions between the Australian and Chinese governments has resulted in a number of tariffs being imposed on Australian exports. However, with the Albanese government now in office for a little over 12 months, signs are emerging in political relations, so I'll certainly be interested to understand Chi's views and if he believes the removal of these sanctions is likely over the next couple of years. Maybe perhaps to start with, Chi, could you provide a few comments for the listeners on your career journey and what your current role with BNP entails today?

Chi Lo:

Sure, Paul. Thanks for the very comprehensive introduction of my background, and accidentally you just tell the audience that I'm old. It's all right. I'm old, and that's why I'm called a senior strategist. That's where the word senior comes in. I've been with BNP for 13 years. I joined BNP from Ping An Asset Management as you alluded to earlier. I've been covering China economy politics markets for 13, 14, 15 years and I still love it because this market, this country is amazing. It's so big, and every day we have something to learn about it. My coverage currently with BNP is, as a senior market strategist, conveying our strategy, our investment ideas and advice to clients, to institutional clients, to wealth management clients, and so on. A broad spectrum of the investment community. I do a lot of external work, client facing and so on, which I enjoyed a lot. As far as this podcast is concerned is one of the favourite things I want to do because I can share my views, our views with audience. Hopefully, will be a mutual learning experience that will help people understand more about China.

Paul O'Connor:

Well, I've certainly been looking forward to this discussion with you, Chi, given your background and your experience. It's interesting. It's both in western countries. Educated in the UK, and you've worked for the Canadian Treasury, and also obviously your Extensive Experience in Asia and knowledge of the Chinese market. The market has priced in slowing growth and recovery momentum and some further policy easing by the People's Bank of China. Why is the Chinese's economy currently losing momentum after such a strong 2022?

Chi Lo:

I think there are two main problems with the Chinese growth momentum, and they are interrelated. First is the loss of confidence that happened throughout COVID with all these lockdowns. Consumers, private sector lost confidence and that's why nobody's willing to spend. When we look at official surveys, the results are still showing that the consumers are not really willing to spend as much as they were before the pandemic. We only saw recently in the past few months, a gradual increase in the willingness of Chinese consumers to spend according to the official surveys. But on the other hand, when we looked at the survey on consumers or household's intention to save, we haven't really seen any decline in the household intention to save, which typically is a sign of lack of confidence among the consumer spending area. That's problem number one. Problem number two, which is related to the problem, number one is the prevailing policy easing stands.

It's not sufficient to turn around this confidence problem in the economy. When we look at the various indicators by the central bank, looking at the central bank policy stance and so on, we only see a very cautious expansionary policy stance throughout COVID up till now. When you pair that with the loss of confidence, it's pretty obvious that the timid policy easing is not strong enough to turn around confidence yet. Confidence is not like a light switch that you can flip on and off. It takes time to recover. I think that the combination of these two problems is basically why the Chinese economic recovery momentum has been feeding after a very strong first quarter start.

Paul O'Connor:

That's very interesting Chi because I think just post the financial crisis, Chinese stimulatory measures in their economy was so significant and very much bought the Australian economy and buffeted us from any downturn really that was being experienced by the rest of the world. It's interesting that the authorities' economic stimulus has been more restrained than perhaps their developed market counterparts. I can appreciate the knock on impact on the consumer. Other than some high frequency economic data, what else should we be monitoring to gauge China's economic health and the policy stance?

Chi Lo:

We need to look at what the PBOC, the central bank does, in order to get up-to-date signals or idea about the policy stance. I looked at three key indicators out of the PBOCs toolkit. These three indicators are related to my point earlier that I argue that the policy stance has been timid, has been too cautious, not expansionary enough to turn around confidence. The first indicator is what we call the credit import, which is simply the ratio of new credit flowing into the Chinese system as a percentage of GDP. The second indicator is the central bank's net liquidity injection through all its liquidity injection facilities including the midterm lending facility, short-term lending facility, short-term lending operation, the PSL. This is long-term lending facility. There's a whole range of lending facilities that is central bank of China uses to inject liquidity, and it is up to its discretion which facility it uses to inject liquidity.

We need to monitor the total net liquidity injection of the PBOC to gauge how loose, how tight the policy stance is. And then the last indicator that I looked at is the real policy rate, which I looked at. I used the seven-day reverse repo rate minus core inflation. When you look at these three indicators in combination, one would get a pretty good idea about how the policy stance is moving. When I look at the data of these three indicators, they all show that a very hesitant policy stance in terms of injecting liquidity, in terms of cutting interest rates, in terms of pumping credit into the system. That's why we have this argument that the policy stands so far has not been expensive enough to turn around confidence problem, which in turn hurts growth momentum. I would argue that one needs to follow quite closely indicators like what I listed out just now to gauge the policy stance, which in turn will give us some clues about how the economy will move.

Paul O'Connor:

It also strikes me, Chi, that traditionally western economies are very blunt with their use of monetary policy, whereas the Chinese seem to be a little bit more micro, so it might take a slightly different lens and thinking to monitor the policy stance of China. Do you think that's a fair comment?

Chi Lo:

The way that the central bank of China conducts monetary policy is different from what we understand in developed markets like ours because very obviously, it is a one step when central banks in our open markets cuts interest rate or raises interest rate.

Paul O'Connor:

It's very blunt.

Chi Lo:

That means liquidity will expand or contract. It's one step. But in China it's two separate steps that the Chinese can announce an interest rate cut to the policy benchmark rate while not touching liquidity. But on the other hand, the central bank of China can inject liquidity into the system through its various lending facilities as I mentioned earlier, but without announcing any interest rate cuts. At this point, the Chinese monetary policy is still a two-step policy in terms of liquidity injection and interest rate changes. They're not one step. I think that's something that the Chinese system will have to evolve eventually so that the system will be more market driven, so that people can get a better hang on how the central bank policy is moving by looking at... Or gauging interest rate moves, which in turn will imply liquidity changes. But at this point, China is still separating the two steps in terms of monetary policy conduct.

Paul O'Connor:

What policy changes might we see if the economic recovery does not progress as many have hoped, and what are the implications on China's asset prices?

Chi Lo:

If the economic recovery does not sustain, I believe Beijing will have to expand monetary policy, fiscal policy more aggressively than what we've seen over the past two, two and a half years. Now, I don't think that the incremental policy easing which the financial market's now pricing in will be sufficient to boost economic growth momentum in China, if the current round of recovery doesn't sustain. We need to see Beijing to be more aggressive, to be expanding monetary policy, fiscal policy broader and also enacting more focused liquidity injection or easing measures to various sectors that are suffering the most. For example, property. For example, consumption and so on. The outlook in case of an economic recovery does not sustain, in our view is a more expansionary, more aggressive expansion macro policy to boost growth momentum so that the economic growth will continue its recovery going forward.

Now, if that is going to happen, that will be pretty positive for Chinese asset prices because we are looking at more aggressive liquidity injection, more aggressive policy expansion to improve growth, which in turn will improve the earnings fundamentals of the stock market of the companies listed in the stock market. Which in turn will be quite positive for Chinese assets going forward.

Paul O'Connor:

And potentially positive, I would've thought for the Australian economy given there could be an increase in demand for commodities and further development in China.

Chi Lo:

Yes, I believe so.

Paul O'Connor:

How about the renminbi exchange rate? Do you think it will continue to fall?

Chi Lo:

In the short term, I think the force is... Depreciating pressure on the RMB is still big. I won't be surprised to see it fall further another three 5%, 7% towards to 7.2 US dollar per renminbi rate in the short term. That is because a combination of concerns about Chinese economy, Chinese growth, the lingering concern about Chinese property market, the negative foreign sentiment or the overall negative sentiment of investors on Chinese assets, on Chinese outlook, and so on. The last point about this negative sentiment has already created portfolio outflows, which have been put big pressure on the RMB exchange rate and leading to exchange rate depreciation. So these short-term forces will remain, but beyond the short term, if the economy recovers on a sustained basis or if we see more aggressive policy as I mentioned earlier, to boost growth further, that could help turn around foreign sentiment or investor sentiment on Chinese assets, which in turn will turn around portfolio flows from outflow to inflow.

Now, that could support the RMB exchange rate. More importantly, when you look at the fundamental support for the renminbi exchange rate, it's still there because current account service is still there. We are projecting a reasonably large current account surplus this year, around 2% of GDP, maybe even more. The overall balance of payments of the Chinese system is still in surplus. That surplus is still expected to maintain because of the current account surplus, because of the expected inflow of capital when foreign sentiment improved on China. Beyond the short term, I would argue that there is a fair chance that renminbi can strengthen against the dollar back below the $7 renminbi level and towards the 6.8 level, or even a stronger depending on how strong capital flow will revert back to China.

Paul O'Connor:

Are you indicating there you think the Chinese authorities will intervene in the foreign exchange market?

Chi Lo:

No, it depends on the behaviour of the exchange rate. The Chinese foreign exchange policy is pretty clear. The PBOC, the central bank will not intervene in the FX market, whether RMB is rising too fast or falling too fast. When the movement of the exchange rate is orderly according to market forces, which is what we are seeing now, that we can easily explain why the renminbi is weakening... And it is not weakening all of a sudden or with high volatility. Given this market situation, this short-term pressures in RMB, I don't think the central bank will need to intervene. It will only intervene when it see disorderly changes in the exchange rate. More importantly, when you look at the policy goal of the Chinese central bank, it does not only target a stable currency between RMB and US dollar, it also targets or wants to target a relatively stable trade weighted exchange rate, which is represented by the CFETS index that the PBOC uses to gauge the trade weighted exchange rate movement of the renminbi against a basket of 20 some odd currencies.

When you look at that currency basket index of the renminbi, it is still above the trading range after the trade war started. Which means that from a trade weighted perspective, the renminbi is not that weak. Which goes back to my argument that the PBOC doesn't really see any need to intervene in the market because it doesn't see the renminbi as a weak currency, and also it doesn't see disorderly market movement of the exchange rate.

Paul O'Connor:

Do you think this is a long-term trend less Chinese intervention in the exchange rate and letting market forces determine it, because that would obviously reduce some tension with the US?

Chi Lo:

Well, definitely. I've been arguing for years that the Chinese authorities are aiming at relaxing control on the exchange rate, letting it drive by market forces more than political forces. There is a very strong theoretical underpinning for that argument, and that is what we call in economics, the impossible unity. Put it very simply, when China opens up the capital account with more capital inflows and outflow between China and the rest of the world, the Chinese authorities can only control either interest rate or the exchange rate, but not both. This is theoretically proven empirically study for many, many years. China is coming to this stage that it is now opening up the capital account, allowing more capital flows in and out of the country, and it has to decide whether it wants to control interest rate or the exchange rate.

When you look at the volatility of the Roman B exchange rate over the past 15 years by calculating simply roaring standard deviation of the RMB exchange rate against the dollar, the volatility of the renminbi exchange rate has been rising, which is a very strong indication that the Chinese authorities are now allowing more market forces to drive the exchange rate rather than keeping it stable by brute force as it used to be some 15, 20 years ago. I believe this is a long-term trend that the Chinese authorities will allow more flexibility and market forces to determine the exchange rate of the renminbi, especially against the US dollar, while trying to have more monetary sovereignty on contouring interest rate so that it can regulate the domestic economic activity through interest rate policy.

Paul O'Connor:

Yes. Well, it certainly makes sense to me there, Chi, because I know something I was certainly taught back at university when I did economics was that all the things us economists get wrong, we get the exchange rate more wrong than anything else.

Chi Lo:

That is very true.

Paul O'Connor:

It's extremely difficult to predict there, so it certainly makes sense that price discovery should be the main direction of what the value of the renminbi is ultimately.

Chi Lo:

Yeah, and let the market decide.

Paul O'Connor:

What is the global impact of China's economic recovery?

Chi Lo:

The global impact mainly comes from trade because China is the largest trading country in the world. The trade angle was pretty simple that for those economies, including Australia, if you export a lot to China and when China recovers, when China grows faster, China buys more from the rest of the world, buys more from Australia. You export more to China, so you get the benefits of the Chinese recovery. There's another angle that China recovery will benefit the world, and that's from tourism. That is from the service part of the Chinese account there, that when the Chinese recovery leads to more Chinese tourists coming back out after the pandemic, visiting other countries, spending money in other countries, and of course those countries that received most of the Chinese tourists will benefit the most when China recovers, and when the Chinese tourists start coming out.

On this account, obviously, Thailand and many of the Southeast Asian countries will be a bigger beneficiaries than some other countries that do not receive that many Chinese tourists. The final angle is the commodity, which I think the impact is not that big because there's a difference between this recovery this time around of the Chinese economy and the last cycles. The past cycles, we saw very large forces going into boosting infrastructure spending, government spending, government investment, property market expansion that drive the economy back to growth. That was the past. This time around, we have seen, as we discussed right in the beginning, very cautious policy including fiscal policy in boosting the economy. We haven't seen large amount of money going into infrastructure spending, boosting investment and so on. We've seen some. The property market, China's government's policy direction in the medium term is to shrink the property market's role in the economy.

It announced it in the March National People's Congress that it doesn't want to see the property market come back in any big way because it wants to see a smaller role of the property market in the economy, so that the resources, the funding, the liquidity can be spared for development of other sectors that the Chinese government wants to develop. The point here is that without a big expansion of the property market, which by implication without a big expansion in construction, Chinese recovery impact on commodity demand is going to be much smaller this time around than we saw in the past few cycles. In our view, in my view, I think the positive impact of the Chinese recovery on commodity this time around is going to be marginally positive, but not as huge as what we saw in the past cycles.

Paul O'Connor:

What about energy, given China's a large importer of energy?

Chi Lo:

Energy is a little different this time because as I mentioned, Chinese tourists are starting to come out. We expect there will be a lot more Chinese tourists to come out of China, just like pre-pandemic, going around the whole world, holidaying, spending money and so on. That big flow of Chinese tourists towards the world, the other countries, it's going to increase demand for flights, which in turn is going to increase demand for oil and so on. Land transport as well, the train, car trips and so on, will also see a significant increase in demand with the Chinese tourists coming out. Now, we've seen already very strong tourism recovery of the Chinese people, but at this point, it's restricted to the domestic market.

We are already seeing Chinese demand for oil increase because of domestic demand for oil and related product that needs to be used in the domestic tourism. But once when the international tourism, the foreign tourism is expected in full force, we'll see more Chinese demand for oil and oil related commodities. That's why I think oil or energy is one bright sport within the commodity sector that will benefit more from Chinese recovery than other commodities.

Paul O'Connor:

I think anecdotally, I've noted in Australia that obviously the Chinese tourist really dropped off when COVID impacted, but I have noted an increasing number of Chinese tourists coming to Australia, and specifically linked to personal relationships I have with Chinese nationals that have migrated here and family now starting to come out more and more. It does seem to be increasing now, even slightly the international tourism, but probably not at the level of it as it was pre COVID.

Chi Lo:

It'll take time for international tourism to come back partly because of the confidence factors that I talked about earlier, and also partly because flights are not really totally normalised in and out of China yet. It will take time for them to be normalised.

Paul O'Connor:

Now turning to the other big issue that's been debated for many years, what about China's demographic situation and problem per se? With a declining labour force and eventually declining population, is the China's growth story over sooner rather than later, and will China's personal wealth peak before their population starts to decline even?

Chi Lo:

The demographic problem in China is a problem, but I am more positive than many market players on the outlook of the Chinese demographics. It's because I think the problem is not going to bite for another 15, maybe even 20 years. It seems that the market talks about this problem as if it is an imminent problem. It's going to happen next week, next year or next two or three years. I don't think so. Now, let me give you some numbers just to put things into perspective. Nothing new here in these numbers, but if you take deep into looking at China's demographic dynamics in 2021, which was the year that we have the most recent demographic data of China, there were about 260 million Chinese in the age cohort between zero and 15 years old. This age cohort, these people, this amount of human beings, they are going to be in the labour force in the next 15, 16 years, right?

We are talking about 216 million plus people from China entering the labour force in the coming 15 years. Another way to look at it is another age cohort between 15 and 40, which is the age cohort of the labour force at this point. In 2021, there were about 460 million people in this age cohort, in the labour force. Even if you advance by 15 years, most of these people currently are working will still be in the labour force. They're not disappearing. And then more importantly is that a lot of these people in this age cohort are still in the rural area, and that's why the Chinese authorities are still so keen on furthering urbanisation, so that they can move more of these people in the working age cohort from the rural areas to the cities and create more new cities, create more job opportunities to absorb the rural labour. We're talking about-

Paul O'Connor:

Grow their burgeoning middle class.

Chi Lo:

... millions. Exactly.

Paul O'Connor:

Yeah. It makes sense. True.

Chi Lo:

Exactly. And then last but not least, when you look at the labour participation rate in China, currently it's about 67%. Now, you compare that with Japan and other old age nation, the labour participation rate in Japan is 79%. If China can do something in terms of changing world incentive, in terms of changing regulations and so on, and move the labour participation rate from 67 towards the Japanese level, 79%, China could easily get another 140 million or so workers keep working. My point here is that this is a problem, demographic is a problem, but it is not a problem that will bite for another 15, maybe even 20 years. So the Chinese growth story is not ending yet.

Paul O'Connor:

I would've thought too, with a growing middle class, a growing services industry and sector of the economy, there's more opportunity for people to work longer into when historically they would've retired. i.e there's less manual work, and there are more service jobs and opportunities. It certainly makes sense that, your comments there Chi. Maybe just to conclude because I know we could talk on all day about China and China's economy. But I Mentioned in my opening of the political tensions between China and the Australian governments. Do you believe the improving relations and increasing dialogue in the last three months will result in any tangible actions including potentially an increasing removal of the tariffs on certain Australian exports to China?

Chi Lo:

Well, if the improvement or if the dialogue between Australia, China and even other developed markets in China continues, tensions will fade when there's more talking, when people are willing to talk things out instead of resort to extreme measures. I do believe that there will be actual measures in terms of reduction in tariffs, reduction in travel. Trade bans and so on happened down the road. We see that happen already. The coal export ban on Australia to China has been lifted recently because mainly of the warming up of the relationship between the two countries. Assuming they keep talking and Tensions keeps fading, I won't be surprised to see there will more constructive measures out of both countries that will be beneficial for both China and Australia. Especially for Australia from the export perspective.

Paul O'Connor:

I guess most importantly with that dialogue, we need to maintain mutual respect for the differences between Australia and China, both the people and the economies there, Chi. But thank you very much for joining us on the podcast today. I could talk on for hours on China. I find it fascinating, the China economy. And having travelled there, it's just a brilliant country to travel to and experience. But thank you for your time and your insights this morning. I'm sure it's been appreciated by the listener and certainly by myself.

Chi Lo:

Pleasure, it's all mine. Thank you very much for the opportunity.

Paul O'Connor:

And to the listener, again, thank you very much for joining us again today on another instalment of the Netwealth Portfolio Construction Podcast series, and I look forward to you joining us on the next instalment. Have a great day everyone.