Friday, August 09 2013
Dalton Nicol Reid attended a CFA Institute conference in Beijing to listen to a range of experts on the outlook for China. Key speakers included Dr Marc Faber (Editor of investment newsletter Gloom, Boom and Doom), Anthony Neoh (former Chairman of the HK SFC and chief advisor to the CSRC), Dr Ha Jiming Vice Chairman and Chief Investment Strategist of Goldman Sachs Investment Management Division) and Dr Clint Laurent (CEO Global Demographics Ltd).
- Shadow banking: An enormous amount of unregulated debt has built up in China. In China there is a large pool of savers who receive little interest rate on their deposits in the bank. Likewise there are projects requiring funding. The major banks have facilitated this by using subsidiaries to lend money and offer high interest rates to savers. The Chinese are auditing these institutions to establish the extent of the shadow banking and ultimately will look to regulate the industry.
- Fixed asset investment: Fixed asset investment has driven the Chinese economy over the past decade as urbanisation has required massive investment. As a % of GDP capital formation has been running at an unsustainable 48%. While there continues to be a strong desire for further urbanisation it is also apparent that the economy needs to transition towards more balance between major drivers of growth.
- Property bubble: The largest risk from our perspective is what appears to be a bubble in housing. The Chinese have excess saving and few prospects for investment. As we have mentioned interest rates at the bank are low, the stock market is tainted by the massive volatility of recent years and by some corrupt new floats and they cannot invest internationally. This has driven investment towards property. The wealthier Chinese will often own multiple apartments and the prices of these apartments are well beyond the average consumer.
- Demographics: China has an ageing population with over 50% over 40 years of age. This ageing process has been enhanced by the one child policy.
Potential Policy Responses
It is quite apparent that while these challenges are significant, the Chinese authorities are well aware of them and are working through policy responses. This is one of the advantages of a command economy – they can take the necessary steps without bothering with burdensome elections.
- Deregulate interest rates: A deregulated interest rate market would appear to offer a solution to shadow banking as it would reduce the need for the industry but would require some degree of deregulation of currency and international capital flows.
- Reduce state influence: Reduce State influence by de-regulating the economy and allowing State owned enterprises to privatise. This would allow these institutions to flourish and allow a transition in the economy from being overly reliant on fixed asset investment and low value add manufacturing.
- Reduce corruption to improve confidence in State institutions and the stock market: This would create alternatives to property investment. We are cautious on outcomes here given there are likely many vested interests at stake.
- Amend the One Child Policy to alleviate demographic issues: We note they are unlikely to radically change this policy as their hospital system could not cope with the number of babies if they adjusted in one hit but we think it likely that we will see a series of changes in coming years.
The key opportunities that we identified were as follows:
- Consumer spending: The mainland Chinese have not yet embraced consumerism in the same manner as those in Hong Kong or Singapore and we see an opportunity for those companies selling to the growing middle class in China.
- As State owned companies are de-regulated we would see opportunities for these companies to invest in themselves and develop brands and value add in manufacturing.
- Pollution remains a significant problem and the Chinese value clean food and fresh air. There is a significant opportunity for Australia to market food and tourism to capitalise on our appeal in this regard.
The consensus view is that the most resource intense period for their economy is likely behind us and we agree with this view.
- RIO and BHP are focused on cost cutting and reducing capex and have underperformed as a result of caution regarding the outlook for China. Progress from the Chinese in establishing the size of the shadow banking industry and introducing policies to de-regulate the economy could result in some renewed interest in the sector.
- We remain cautious on mining service players given the most commodity intense period is behind China.
- Companies selling high end consumer goods, tourism and food can potentially benefit from future growth.
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