China investment story over as risks become elevated

Investors have poured money into China for a generation but changes under the Xi regime spell the end of the story as we know it.

Under President Xi Jinping, the China investment narrative has changed. Above, visitors take photos of a banner illustrating a book by Mr Xi at the annual Hong Kong Book Fair in July. Picture: AFP

Is the China investment story as we know it finished? In the same week China-dependent Rio Tinto delivered the biggest half-year dividend in Australian corporate history, the issue is unavoidable.

For a generation, Australian investors have warmed to the theme: as China develops, we invest to partake in the rich rewards for co-prosperity.

The problem is that China increasingly shows no regard for this narrative. “Market intervention” is now the name of the game: the Communist Party comes first and no stock or sector is safe.

It’s one of the reasons the tech titans Amazon and Apple were sold off this week even after record-breaking results. It’s the context behind A2 Milk’s share price almost halving this year, or why a “country fund” such as the iShares China Large Cap ETF is down 7 per cent in the past week.

The story that seduced investors goes back to the 1980s reign of Deng Xiaoping and what Harvard’s Richard Vietor tagged as among “the most successful development strategies ever” as China liberalised the economy while maintaining state power.

Now under President Xi Jinping, the narrative has changed.

In recent weeks the drama has been about the clampdown on tech stocks and the spoiled floats of groups such as Alibaba or Uber-rival Didi. This week the clampdowns took a new direction into private education – the listed industry saw huge losses after a rule change that rewrote the rules for this sector, mandating that it must now become “non-profit”.

According to Goldman Sachs, Chinese shares listed on overseas markets have lost $US1 trillion ($1.35 trillion) since February.

Talk about regulatory risk! This is a new dimension. It is elevating risk in relation to all China-related investments, and for Australian investors that means not just the sharemarket but all two-way commercial activity.

In many ways, the cost of the deterioration in Australia’s relationship with China has been masked by our iron ore miners. Unlike coal, wine or barley, China is not in a position to ban Rio, Fortescue or BHP because it does not yet have an alternative source of supply.

But that won’t last forever. This week, CBA commodity analyst Vivek Dhar warned of China “accelerating measures to reduce their dependence on Australian iron ore”. As Dhar points out, 50 per cent of all iron ore into China comes from Australia. But that dominance has most likely peaked, with China set to reduce its Australian dependence by increasing imports from Brazil and, ultimately, from Africa.

More importantly, Dhar suggests China will progressively use less iron ore as the economy ­matures from commodity-intensive projects to a service-based economy. And in many ways that’s the kernel of the issue – times have changed, the China that investors bought into 10 or even five years ago is no more. “China is more emboldened now and can better afford isolation on some issues,” says Peter Cai, project director, Australia-China relations at the Lowy Institute.

That’s why China has stood by as the Hang Seng index in Hong Kong has sunk by 10 per cent over the past six months while many of the world’s leading markets posted useful gains. As former prime minister (now UK trade adviser) Tony Abbott warned in widely reported comments midweek: “The Beijing government sees trade as a strategic weapon to be turned on and off, like a tap.”

Of course, there are two sides to the story. With each clampdown, China puts forward a justification – the clampdown on tech stocks is related to data, with ride-share stocks its to do with worker conditions, with private education it all relates to undue pressure on students.

But investors are not listening to these explanations. Rather, they fret over which shares or funds will be pummelled in the next “reform”. On the ASX, investors more lately have discovered how China – or even fears concerning China – can change the outlook. Our biggest listed telco, Telstra, was recently approached to co-invest with the government in bidding for Digicel Pacific. The imperative was political, not economic.

Intelligence agencies in Canberra are worried that Digicel ­Pacific may be bought by China Mobile. But there is no available evidence as yet that China Mobile is even interested in these South Pacific assets. No wonder Telstra chairman John Mullen is obfuscating on the issue. It’s an unlikely story but one that smacks of how deeply China’s aggressive tone has changed the game for all investors.

Where will it stop? “If you look at fund flows, international money is still pouring into China, but the risks have clearly become elevated,” says Cai at the Lowy Institute.

The momentum remains in China’s favour. But it’s hard to believe it will remain so – especially if China keeps closing its doors.