JPMAM - The Great Call of China
A primary issue for China over the next few years will be to rebalance its economy away from public investment and more towards private consumption, according to Pinakin Patel, Client Portfolio Manager of Asian Equities at J.P. Morgan Asset Management.
Patel says: "Premier Wen Jiabo's comments back in 2007, when he said: ‘The biggest problem in China's economy is still the imbalances in the structure - that economic development is not stable, balanced or harmonious and sustainable,' still remain very relevant today."
Patel adds: "Political considerations will increasingly become an issue especially in economic policy in the next few years. 2012 will see the transition of power to the fifth generation as the incumbent administration of President Hu Jintao and Premier Wen Jiabao draws to a close. The legacy of both the President and Premier and their influence in the next administration will be determined by the country's economic performance over the next few years."
Risks
Patel notes that when talking about investment in China it is important to detail the principle risks as well as the opportunities that exist.
Inflation - China will shift from a period of deflation to inflation over the next year, food prices being the key indicator. Food CPI inflation is currently low and down from the peak in February 2008 of 23%. With unemployment and excess capacity high, there is a very low probability of high inflation next year and it should not rise above 4%, as domestic overcapacity will limit price increases for manufactured goods.
Currency - Patel expects the RMB to remain flat versus the USD until mid-2010. The chance of a significant devaluation is very small since any benefit to exporters would be outweighed by the damage with the existing US administration. The Chinese will merely resume the policy (adopted in 2005) by mid-2010 when GDP growth has stabilised at about 8-9% and exports are back in positive territory, recognising that gradual appreciation of the RMB against the dollar is in China's self-interest. There will be a return to gradual appreciation, on the order of 3-5% annually.
Policy risks - the timing of the government's exit strategy will be vital, because if they wait too long to begin withdrawing the stimulus it could potentially lead to over-heating, while if they withdraw it too quickly it could lead to a relapse of sluggish growth.
Expectations for 2010
Despite these risks, Patel is keen to point out that investment opportunities in the region are still rife and predictions of a ‘bubble' forming in China could be premature.
He said: "The negative drain on GDP from exports, looks set to turn around next year. Whilst we are not expecting to see a strong recovery in exports as such, what is important is the percentage change and not the absolute level. Net exports subtracted some 4.0% from GDP growth this year, whereas next year net exports are expected to contribute 0.0 -0.5% to GDP.
In addition, the main driver of growth in 2009 has been the huge RMB 4 trillion (USD 580 billion) stimulus package that was announced last year. Looking into 2010 the impact of the package is expected to decline. We do not expect the government stimulus to decline in absolute terms; however, the rate of increase will be smaller than this year, somewhat offset by an increase in the contribution of GDP coming from exports."
At the time of the announcement of the Q3 GDP numbers, the National Bureau of Statistics spokesperson said Beijing would continue to "insist on the proactive fiscal policies and moderately lenient monetary policies" and that "the overall situation of the national economy was good". This signals that the authorities are unlikely to introduce any major policy tightening in the near term.
The government may well also look to address a number of areas of reform in 2010 that they have neglected over the past few years, such as the development of a pension system, adjusting utilities prices such as electricity, gas and water prices and potentially further opening up the services sector.
Patel concluded: "China remains an extremely attractive market and is not expensively valued considering that interest rates are at a multi-year low and government policy is restraining liquidity. Despite the presence of risks in the region, the banking system looks healthy as does the property market and valuations appear to look reasonable, certainly for the foreseeable future."