China - is the party over for investors?

Standard Life Investments, a leading investment house, predicts that inflationary pressures in China will create difficult decisions for policy makers inside and outside the country.

While China will remain a fast growing economy, the investment house believes that the composition of that growth is not yet determined, creating risks and opportunities for investors. In the latest edition of Global Perspective1, the global fund manager analyses some of the key issues facing the Chinese economy over the medium term. It argues that investors are overly worried by short term issues, such as food prices affecting headline inflation. Standard Life Investments warns that of more concern are the rapid pace of money supply and wages growth, and hence the start of a trend towards exported inflation. This could have implications for monetary policy in western economies.

Andrew Milligan, Head of Global Strategy, Standard Life Investments, said: "With China likely to account for such a large percentage of incremental global growth in the next few years, global investors will inevitably become more sensitised to macro indicators coming out of the country. Chinese policy makers face growing tensions, for example between the demands of central and local government, between the relative importance of the manufacturing and service sectors, or between the desire for monetary control versus the pace of liberalisation in financial services. While we certainly expect China to continue to grow solidly in coming years, the composition of such growth and its side effects could have more negative consequences than many investors expect. Put simply, it is not clear whether China will retain its bias towards exports and property or shift towards consumption and services.

"The House View has previously recommended that investors consider gaining exposure to emerging markets, such as China, through the export and local production capacity of many companies quoted in western stock markets. Significant further monetary policy tightening is expected in China, a strong cautionary signal to investors, not only in Chinese assets but also for investors with Heavy positions in emerging markets equities. The House View reflects these new concerns and has taken the opportunity to move Light in Asian equities using the proceeds to invest in the more defensive US equity market. With the Chinese stockmarket in a long drawn out bear market since late 2007, as and when sufficient bad news about the inflation situation and the monetary policy response to it has been priced into markets, then a useful entry point into Asian as well as Chinese shares may eventually approach."