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What bugs foreign investors about China?

Updated: Saturday June 14, 2014 MYT 9:20:56 AM

What bugs foreign investors about China?

BY TAN SRI LIN SEE-YAN

I spent the last week of May at Shanghai’s Fudan University – attended two global conferences there. The network is quite fantastic, full of “lao-wai” (foreigners) academics and policymakers seeking analytical clarification on four main areas of concern: (i) Surely, China can’t keep on growing at 7.5%; (ii) Is the property bubble going to bust? (iii) Will China ever reform?; and (iv) Can the yuan go international? Investors expect wrenching change. Here’s my take.

Growth at 7.5%

Yes, growth in first quarter of 2014 slackened to 7.4% (down from 7.7% in fourth quarter 2013), a six-quarter low, reflecting weaker industrial production, lower fixed-asset investment, and poorer retail sales. China is in transition, changing from a long but fast and hurried phase driven by abundant capital and labour (reminiscent of the United States in late 19th century) to a more mature development track where growth now rests more and more on productivity gains. At this point, economies like Brazil and Malaysia are already locked in “the middle-income trap” (MYT), whereas South Korea and Taiwan powered through and lifted “the bar” to become more competitive and productive, hence wealthy.

To avoid MYT, China’s focus is on raising the quality of growth and changing its economic structure to improve peoples’ well-being, adapting to “new normal” conditions emphasising inclusiveness, social stability and less debt. A new policy framework appears to have set-in: (a) investment is no longer the main growth driver (consumption will pick-up and sustain the process, with services leading the way – this sector rose to 40% of gross domestic product (GDP) in 2013, up three percentage points in two years); (b) fiscal and monetary policy will not provide unlimited support to drive growth and ensure inflation is kept below 3.5%; (c) urbanisation will remain the long-term driver to sustain growth (this involves continuing investment in infrastructure and building the social safety net to reduce precautionary savings to boost consumption and develop services); (d) growth remains critical to promote employment creation: a one percentage point of growth generates 1.5 million new jobs; 10 million jobs to keep urban unemployment at 4.6% means the economy has to grow by at least at 7.2%; and (e) fiscal policy will remain proactive and monetary policy, relatively relaxed – indeed, it has since eased further to allow selective banks to lend more to small borrowers.

It is likely the second quarter GDP will rise to 7.5% and then moderate, even though exports should expand as external demand rebounds, as would imports. Inflation moderates. Growth will slowdown.

Property bubble to burst?

The property market remains delicate after a bumpy start in 2014. It does appear the slump is deepening, despite new efforts to give home sales a lift. The government is entreating banks to lend more, hoping to reverse the nearly 10% nationwide fall in housing sales in the first four months of this year. New construction starts have fallen almost 25% over the period. It’s clear real-estate prices have peaked. But buyers are holding back because of overbuilding and the slowdown in income growth. China imposed limits on the market four years ago to cool down prices, fearful of a housing bust. Since then Moody’s has revised its credit outlook to “negative” (from “stable”), citing falling sales and rising inventories. What’s happening is largely cyclical.

Housing prices will remain generally stable in most first and second tier cities, where inventories are not so high as in third-tier cities. Most large developers, I am told, are sufficiently strong financially and are unlikely to slash prices to liquidate unsold stocks. Housing prices in China are still far below global highs – in the likes of London, Hong Kong, Singapore, New York, Mumbai, Tokyo or Sydney, even Taipei. So long as urbanisation continues, demand for property will remain elevated. Overall, China’s property market is unlikely to tank!

Reform in China

The Chinese Communist Party (CCP), with 82 million members, dominates the state. The core of its power rests with the 24-member Politburo whose affairs are managed by a seven-member standing committee, headed by CCP’s secretary-general who becomes the president of the state. The CCP runs a five-year National Congress (Parliament), with its central committee (CC) meeting several times in between. The CC comprises 204 members which hold plenary sessions: its third focuses on economic reform issues and its fifth, five-year plans.

At the recent third Plenum, three clear reform directions were set: (i) markets will play a “decisive” role in resource allocation, while government pushes for market-based reforms; (ii) both public and private sectors are important, with businesses being given bigger market access; and (iii) China is to be ruled by laws but not by the rule of law. Reform details are discussed in this column of Dec 14, 2013: “China’s Third Plenum Reforms Are Well Received, But The New Deal Flashes Danger Signals.” As I see it, the sweeping change concerns the major restructuring of power – formation of two new super-ministerial groups, one on foreign and domestic security and defence; and the other to plan and carry-out comprehensively deepening reforms.

Both these groups are headed by the president, with the Prime Minister’s role still unclear. It fundamentally uproots the working arrangement between party and civil government first re-organised under former Premier Zhu Rongji’s reforms in 1994. That arrangement sets the Party at the top of the policy-making and structural framework of government, leaving civil authorities to be responsible for effective delivery and efficient administration.

The new structure will drastically eliminate this institutionalised bureaucracy, cutting layers of paperwork. Essentially, the new reforms inject personal power into the sclerotic system, where rules are seen as stultifying and an impediment to the ability of the final authority to impose its will. Reform thus depends on the resolve of the president. There won’t be the usual roadmap towards liberalisation; no new rules and regulations to implement. That’s drastic reform by any standard.

Yuan liberalisation

US yuan “bashing” is classic political denial. The facts: yuan has since depreciated by nearly 3.5% from its Jan 14 high. But it had appreciated 36% since June 21, 2005 when yuan floated. So, over nine years, yuan is still up 32.5% net – close to fair value, I think. Indeed, the International Monetary Fund concedes that yuan is now “moderately undervalued” by 5%-10%. This is so because the People’s Bank of China (PBoC) purchased US$510bil in forex reserves in 2013 (a record in a single year) and US$130bil more in the first quarter of 2014, bringing national reserves to US$4 trillion. PBoC’s latest moves form part of currency reform measures in relaxing control over the float (widening the trading band in mid-March 2014 to +2%, from 1% previously), coupled with the recent 3% depreciation to punish speculators that one-way yuan bets are hazardous (dampening inflows of hot money in the process); and partly laying the groundwork for supply-demand based deposit-rate liberalisation, set to take place by end-2015. The reality is that interest rates will eventually rise significantly, resulting in a stronger yuan. But, PBoC will likely intervene to “moderate” market forces to move yuan lower (not higher) to stabilise the economy. So, with things in a flux, moves toward any new equilibrium will only bring forth a “Robinsonian chimera” of sorts, in the face of monetary easing made necessary to smoothen the impact of deposit-rate reform. The interplay of monetary and exchange rate policies gets complex as the ultimate aim is to create employment. Still, reformists liken yuan liberalisation to World Trade Organisation accession: a way to pressure powerful lobbies to reform.

What then, are we to do?

When it comes to China, I am afraid analysts like me from the outside looking-in carry three articles of faith – (i) belief that China still needs to grow rather fast (at least +7%) to create enough urban employment; (ii) belief that Beijing has sufficient resource-leeway and policy tools to bring-on quality growth to meet social aspirations; and (iii) belief that the leadership is committed enough to implement market-driven reforms to eventually get a fully-convertible yuan, now the world’s seventh most-used currency.

Former banker, Tan Sri Lin See-Yan is a Harvard-educated economist and a British Chartered Scientist who speaks, writes and consults on economic and financial issues. Feedback is most welcome; email: starbiz@thestar.com.my

 

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About bambooinnovator
KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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