Re­tain­ing a bullish tone on China

The Pak Banker - - OPINION - Michael Hasen­stab

Astrong equity mar­ket car­ries ben­e­fits for China: It pro­vides a more at­trac­tive back­drop for IPOs, and for pri­vate equity fi­nanc­ing, open­ing up a new fi­nanc­ing op­por­tu­nity for small and medi­um­sized en­ter­prises which have more lim­ited ac­cess to credit. Two, it creates a bet­ter back­drop for pri­vati­sa­tion, sup­port­ing the sta­te­owned en­ter­prise (SEO) re­form process; and (iii) as share own­er­ship has broad­ened over the course of the rally, it can also give some sup­port to do­mes­tic con­sump­tion via a wealth ef­fect, even if lim­ited (equity own­er­ship re­mains ex­tremely low in China at less than 2 per cent of house­hold as­sets).

Pol­i­cy­mak­ers are try­ing to strike the right bal­ance. They want to pre­vent a stock mar­ket crash, which would not only pose a risk to eco­nomic growth, but also set back the progress in mak­ing the equity mar­ket a more im­por­tant part of the econ­omy, both as a source of fi­nanc­ing for cor­po­rates and as an in­vest­ment op­por­tu­nity for savers. They will pre­fer, how­ever, to help the mar­ket sta­bilise rather than to fuel an­other sharp run-up in val­u­a­tions that could set the stage for a fullfledged crash.

Over its rel­a­tively short his­tory, China's do­mes­tic stock mar­ket has been prone to ex­treme fluc­tu­a­tions, partly be­cause it has been closed to in­ter­na­tional in­vestors. And al­though China's stock mar­ket still plays a rel­a­tively mi­nor role in its econ­omy, both as a source of cap­i­tal for com­pa­nies and as as­sets for house­holds, its im­por­tance on both sides has in­creased. Last sum­mer, the Chi­nese govern­ment adopted a num­ber of ad­min­is­tra­tive mea­sures to halt the fall in stock prices af­ter a cor­rec­tion that alarmed in­vestors around the world. It is worth re­call­ing that the cor­rec­tion at that time came af­ter val­u­a­tions had more than dou­bled over the pre­vi­ous 12 months, but it did not pre­cip­i­tate the fully fledged crash that some ob­servers had pre­dicted.

The Peo­ple's Bank of China (PBOC) has once again in­ter­vened to de­value the yuan, and once again some com­men­ta­tors are in­ter­pret­ing the de­val­u­a­tion as a sig­nal that pol­i­cy­mak­ers re­main deeply con­cerned about the growth slow­down. While some ob­servers feel the Chi­nese au­thor­i­ties may seek to en­gi­neer a sub­stan­tial de­pre­ci­a­tion to boost growth through ex­ports - lead­ing to cur­rency wars that may dis­rupt global growth and the global fi­nan­cial sys­tem - our view is dif­fer­ent.

We be­lieve China's pol­i­cy­mak­ers will most likely stay the course. We would note that be­fore the de­pre­ci­a­tion in Au­gust 2015, China's cur­rency had ap­pre­ci­ated by over 12 per cent on a real ef­fec­tive ba­sis in the pre­ced­ing 12 months. Fur­ther­more, China had ex­pe­ri­enced some "hot money" out­flows dur­ing the first-half of the year, which also clearly in­flu­enced pol­i­cy­mak­ers' ac­tions. Al­though the ren­minbi has ex­pe­ri­enced a mod­est de­pre­ci­a­tion, we do not feel the move is a pre­cur­sor to a larger un­con­trolled weak­en­ing, as feared by mar­kets.

We do not share the mar­kets' cur­rent pes­simism over the tra­jec­tory of China's eco­nomic growth. We view the re­cent mod­er­a­tion of growth in China as an in­evitable nor­mal­i­sa­tion for an econ­omy of its size; its nom­i­nal level of gross do­mes­tic prod­uct (GDP) is now five times the size of what it was 10 years ago. Thus, a lower rate of growth still rep­re­sents a mas­sive level of global ag­gre­gate de­mand.

In our as­sess­ment, the qual­ity of growth in China has im­proved in re­cent years. In­creas­ing labour costs and in­ter­est rates have put down­ward pres­sure on prof­its. How­ever, higher wages boost con­sump­tion, which has in­creas­ingly be­come the an­chor of Chi­nese growth. We es­ti­mate that con­sump­tion is close to 60 per cent of GDP and ris­ing. Ad­di­tion­ally, new in­ter­est-rate lib­er­al­i­sa­tion poli­cies can re­di­rect cap­i­tal to the whole econ­omy, par­tic­u­larly the pri­vate sec­tor, which we ex­pect to be the fu­ture driver of growth.

The pri­vate sec­tor in China now con­trib­utes more to job growth than the sta­te­owned, which has not been the case for the past 30 years. China's rapid ur­ban­i­sa­tion process will also ne­ces­si­tate de­vel­op­ment. Plans for in­fra­struc­ture in­vest­ment are un­der­way as the rail­way is set to ex­pand along with de­mands for broader wa­ter pu­rifi­ca­tion and en­vi­ron­men­tal projects. Such projects could some­what off­set the neg­a­tive drags on growth from the con­trac­tions in man­u­fac­tur­ing and the ex­cess ca­pac­ity in the real es­tate sec­tor. Fur­ther­more, prop­erty prices ap­pear to have bot­tomed out due to ear­lier eas­ing mea­sures.

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