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Fall in China tech stocks may open up opportunities

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China is actively shaping its technology sector to ensure governmental control, accountability and reduced interference with its social agenda. Indians investing in China need to understand the long- and short-term impacts of these moves to make the right decisions.

The story behind China’s recent crackdown on its edtech companies is one that Indians can easily understand. Rising disparity in online education resources available to students, based on their economic profile, is laying the ground for starker inequalities in future. In a bid to level the field for all students, the Chinese government announced the following restrictions on 24 July: Edtech companies offering school curricula cannot do so for profit; they cannot raise funds via IPOs either; edtechs can only offer enrichment classes for peripheral subjects or subjects not taught in school; no tutoring related to the school syllabus can take place on weekends or during vacations ; no online and academic classes can be taken for children under the age of 6; foreign capital cannot participate in the private education sector through methods such as mergers and acquisitions, entrusted operations or franchise chains.

This is a fundamental blow to the profitability of the edtech sector in China, valued at $100 billion. However, in terms of impact, the measures are focused and unlikely to have much impact on the broad tech sector. Why then did the market have such a severe reaction to the regulatory moves? What are the short- and long-term impacts that markets are trying to price in?

Expect more reforms, and volatility, in the short term: Specifically, fund managers and investors closely watching China expect the governmental reform of tech to continue in a bid to downsize the growing influence of any one company or group. In the short term, therefore, we see the following impacts playing out in the Chinese tech sector: Compliance costs will rise; expansion plans may slow down; a change in business model or operational practices will be considered; return ratios may contract as national service obligations gain precedence over profit maximization; potential for raising funds outside China will be reduced as Chinese regulators would want to retain control of tech capital within China; and the US may prevent Chinese tech companies from listing on US stock exchanges because of the ongoing tensions. All of these will cause volatility and depressed prices in the short term, with limited scope for any positive news.

Long-term China story remains strong: The Chinese government is not insensitive to the impact of its regulatory overhaul, and has signalled assurance to investors, clarifying that the sustainable growth of China’s tech sector will not be hampered. Our analysis reveals the following tailwinds continuing to work in favour of China’s tech sector in the long term: Growing consumption and tech adoption will increase revenues; greater transparency in disclosures will help attract inflows from investors due to increased confidence in the markets; business models will be reoriented to reduce linkages/dependence on the US; greater emphasis will be laid on innovation and opportunity-tapping primarily in the domestic market and regional markets in Central Asia and Africa.

Apart from the tech sector, the broader China market continues to remain strong, with economic indicators and capex back at pre-covid levels. Stocks in defensive and secular sectors such as fast and online retailing, consumer durables and media are valued at a premium, and are gradually increasing their weight in the headline indices.

What Indian investors should do: Understanding the long-term and broader market prospects of China is important for Indian investors to not overreact to the recent drawdown. The two overseas mutual funds investing in Greater China—Axis Greater China Equity Fund of Fund and Edelweiss Greater China Equity Offshore Fund—both have no exposure to the Chinese edtech sector. The fund managers in both cases are eyeing opportunities beyond tech (on a bottom-up basis) in sectors benefiting from government policy direction, local consumption demand, manufacturing, supply chain localization, electric vehicles; solar energy, and net zero carbon target.

In conclusion, existing SIPs should be continued to ensure cost averaging through staggered investing. The current decline in the Chinese stock market also represents an attractive tactical opportunity for investors to start investing in China, or to increase their exposure.

Krishna Karwa and Rachana Makhija are senior research analysts, iFAST Financial India Pvt. Ltd.

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