HSBC Global Asset Management on outlook for China

One-on-One with Richard Wong - Investment Director, Equities, Halbis, HSBC Global Asset Management.

Q: Is China on track to achieve its target of 8% GDP growth for this year?

A: We think China is well on its way to achieving more than 8% GDP growth this year. China recently announced third quarter GDP, which grew 8.9% year-on-year, an improvement from the 7.9% expansion for the second quarter and the 6.1% growth for the first quarter. China has achieved 7.7% growth so far this year. As the fourth quarter of last year was extremely weak, we expect growth for the last quarter of this year to be even stronger. As such, GDP growth should exceed 8% this year.

It appears the market's focus has already turned to the growth outlook for next year. We expect China's strong growth to be sustainable in 2009, driven by both existing and new infrastructure projects and robust domestic consumption. China's retail sales gained 15.5% year-on-year in September, the quickest in eight months.

In addition, we are seeing improvements in China's exports. Although Chinese exports declined by 21.3% year-on-year in September, overseas sales have recovered since June on a month-on-month basis. For September, exports grew 6.3% month-on-month, an improvement from the 3.4% increase in August. Similarly, we expect exports to continue to improve in the fourth quarter due to the low base of comparison last year.

In summary, we remain positive on the growth outlook for China next year due to the combination of ongoing infrastructure-led investment, resilient domestic consumption growth and a turnaround in Chinese exports.

Q: In the State Council's latest statement, it mentioned for the first time the need to manage inflationary expectations and balance growth. Does this signal China will raise interest rates soon to avoid overheating as the economy has rebounded strongly this year?

A: The government is unlikely to raise interest rates soon as domestic manufacturing and exports remain weak. Profits at China's leading industrial firms declined 9.1% in the first nine months of the year, although this was a 1.5% improvement from the first eight months.

As mentioned previously, though exports have improved, they still declined 21.3% year-on-year in September.

In addition, inflation is still negative in China, so there is little immediate impetus to hike rates to contain inflation. The latest CPI figure for September is -0.8%, although this is less negative than the August figure of -1.2%. We do not think inflation will surpass 3% next year.

Generally speaking, if we look at the CPI component, food is up 1.5%, but if we exclude this component, the rest of the pricing in the economy is still negative, to the magnitude of -1.9%, which is little changed from August's -2.0% level. Therefore, we are not that concerned about inflation, or at least for next year, and under this scenario, we do not expect any interest rate hikes by the government.

Q: What is China's likely exit strategy if they have to lessen stimulus measures?

A: Next year, if exports recover strongly and private investment can pick up from the lead of government spending, China could start to gradually lessen stimulus measures by reducing or slowing down infrastructure spending.

It would be logical for China to start to gradually withdraw stimulus support as it would be unhealthy for the government to continuously support the economy through investment spending, which has been one of the biggest drivers of China's economic recovery this year.

While the market is concerned stimulus measures might be withdrawn, this should not be viewed negatively as the government is unlikely to tighten monetary and fiscal policies until it sees clear signs of recovery.

Even if the government withdraws stimulus measures, it has the flexibility and capability to reapply them again if recovery stalls. China has foreign exchange reserves in excess of RMB2 trillion, the largest in the world, giving it the capacity to achieve at least 8% GDP growth.

So generally we think we should not be too worried about China exiting from the very loose monetary and fiscal policy that it has maintained to support market confidence.

Q: How best can China make a transition and encourage business and household spending to pick up the lead from government stimulus?

A: Investment in China has been largely driven by the government. Increase in investment by the private sector is necessary to ensure sustainable economic growth. As such, government incentives to encourage consumption and private investment are important.

So far, measures by the government to boost consumption have been successful, such as the subsidies on household appliances and auto purchases, as well as the preferential mortgage rate for first-time home buyers. For enterprises, the government has given tax credits and incentives for manufacturers to upgrade technology and production facilities. Such incentives are gradually encouraging Chinese enterprises to raise efficiency and move up the value chain and we expect more effort by the government in this area to drive improvement.

The RMB4 trillion stimulus package announced by China last November is not entirely for infrastructure investment. Some of the spending has been allocated to technology upgrades as well. The spending plan has been well conceived, and it has actually been promoting industry improvement during the downturn.

Investment by Chinese enterprises grew by about 1% in September. While this growth is slow compared to the 33% increase in overall fixed asset investment, we are starting to see some encouraging signs. For instance, investment by Chinese property developers rose by more than 17% in September and there are signs foreign direct investment is picking up again.

As exports continue to improve, this should encourage further private investment. We think this will be a good way to lead the economy by encouraging improvement in efficiency during a period of sluggish sales. When demand picks up again, domestic enterprises would hopefully be in a better position to take advantage of that growth as they will be leaner and will be able to enjoy better profit margins.

Q: What's your view on the Chinese property sector given asset-inflation concerns and worries over liquidity growth next year?

A: We have become less bearish on the Chinese property sector . As property prices have risen significantly this year, we were concerned buyers would delay purchases in anticipation of further government measures to support the property market.

But since the Golden-Week holiday, which was in the first week of October, we are seeing a very strong pick-up in sales across the country. In the major first-tier cities such as Beijing, Guangzhou and Shenzhen, volume sales have rebounded by between 40% and 80% week-on-week, taking transaction volumes back to levels in June/July, which is quite encouraging.

We were also concerned about the large number of companies in the property sector raising cash through IPOs. We have seen some of that coming through, but we think quality property companies will continue to perform.