China faces balancing act

As the global spotlight focuses on China's human rights record, the crackdown in Tibet, high inflation and increasing social unrest, Mike Hanbury-Williams, manager of the F&C Pacific Growth and F&C Asia Dynamic funds, believes that the long-term growth story remains intact despite short term challenges in controlling food prices.

Hanbury-Williams argues that the Chinese economy will slowdown as a consequence of the deteriorating export environment and concerns about recession in both the US and Europe.

"However, we think that domestically the economy will continue seeing growth, maybe at a slower rate closer to 8 or 9% GDP growth, compared to the plus 10% rates we have seen in the past."

Headline inflation numbers in China are currently running at over 7% driven by rising commodity prices, in particular food prices. "However if we look at underlying inflation ex-food in China the rate is still below 2%. So the clear concern at the moment is to do with food prices and the social unrest they can cause."

The Chinese government continues to adopt a tight monetary policy, both in terms of higher reserve requirements for banks and also increased interest rates. "They are restricting lending by the banks in order to try to slow the economy down and improve the quality of the growth going forward. They are also looking at reducing import taxes and potentially increasing subsidies to allow prices to remain low," he explained. "The problem they face in this environment is that if they keep prices low, then the demand side can create shortage. If they let prices rise, people won't be able to afford basic commodities. It's a difficult balancing act," he commented.

Hanbury-Williams explained that prior to the beginning of the year he was expecting Chinese inflation to peak at the end of Q1 or early Q2. However damage to crops caused by recent snow storms has slightly changed his outlook. "It seems that it will now take longer for us to see an improvement in headline CPI, probably until the second half of the year."

In terms of investment opportunities, Hanbury-Williams continues to back domestic-orientated stocks over export-related ones. "We remain exposed to both hard and soft commodities but we have done some small trading between various different commodities and also between the different stages of the chain in the commodities cycle. Within soft commodities we have taken the top of our palm oil exposure when we saw prices spike in the first quarter and moved that money into companies that are looking at crop protection."