China was never at the heart of the global financial crisis, yet in the past two
years worries over China’s economic future have not been relieved. The media
warned China a year ago about its massive overcapacity and an impending
Today the case is just the opposite and the international community is more
concerned about China’s overheated economy. China’s moves to raise overall
wages and to introduce an exchange rate regime reform have topped the
headlines recently. Although China of course faces challenges ahead, we do
not think there is much cause for concern.
China has successfully weathered the global financial crisis, thanks to the
governments massive stimulus plan and the central banks huge liquidity
injection. China’s inflation adjusted GDP growth rate in the first quarter of this
year has surged to 11.9%. To some observers, this signals that the economy is
excessively overheated. After all, no major economy except India has realized
a growth rate near 10% this year.
I do not agree with the alarmist talk mentioned above. An 11% real GDP
growth rate is not unprecedented in China. Over the past decade China has
realized average annual growth of 10% without a sharp rise in inflation. Of
course China will not be able to grow at this rate forever. It is estimated that China’s
GDP growth will ultimately maintain a more reasonable and sustainable level
as economic development advances and demographic structures shift. This
leveling off will be realized over the next decade, rather than the next few
However, even though the economy is not at fever pitch, GDP growth rate may
still fall because China’s central bank is adopting aggressive tightening policies.
Yet it is believed China’s central bank is doing the right thing because the rate of
inflation has risen rapidly and surpassed 3% and is likely to reach 5% in the
next few months. Recently, the other focal point (house prices), show signs
of stabilizing. In this case, China is very likely to maintain easier
macroeconomic policies this year. One year after China has implemented a
stimulus plan to boost the economy, it surely does not want to risk putting a
brake on economic growth.
In fact, I foresee that China will not be able to sustain the same rapid growth
in the second half of this year, and almost all the Asian economies face the
same reality. This should be the result of the withdrawal of fiscal incentives and
the weakening of positive base effect.
On June 19th, China’s central bank announced exchange rate reform in order
to enhance the exchange rate flexibility of the renminbi. I think the renminbi
will appreciate in a mild manner rather than climb sharply. This appreciation
will help curb inflation and stimulate domestic consumption.
Disputes over wages especially in foreign funded companies, has become the
hotspot recently. Several companies have promised to raise salaries over 10%.
This may sound too high, yet it is noteworthy that a double digit wage hike is
not rare in China. The manufacturing industries posted an average 14.5% rise
in annual salaries during 2004 and 2008. Wages did not rise in 2009 only
because of the financial crisis, so there is room for the current and future wage
From a purely economic perspective, wages should be aligned with labor
productivity growth. In recent years, wages have continued to grow to a level
close to the inflation. In addition, investors should bear in mind that although a
rise in the cost of labor will affect the profit margin of a certain company, it also
provides the best support for China’s transformation into an economy more
driven by consumption.
China is facing challenges ahead. A miss step in government policies may result
in a temporary economic setback. Even in this case, China will still enjoy a
brighter outlook than many other countries. Meanwhile, China is still among
the primary destinations for international equity investors given the reasonable
valuation of Chinese stocks listed in Hong Kong. The recent unhooking of the
Renminbi from USD will further catalyze the growth of the Chinese market.
2010 Second Half Year Investment Strategies for the Chinese A – Share Market
It is very likely that the Chinese A – share market will be fluctuating downward in
the second half of the year due to the impact of control policies on real estate
market and the quicker progress of China’s economic restructuring.
Cyclically, the Chinese A – share market is moving along with the control cycle
of the real estate market. The ongoing impact of the real estate market
austerity measures will further slow down economic growth. This impact is
expected to last at least until the end of 2010. Structurally, the de-leverage
process introduced during the 2008 financial crisis is continuing globally and
as a result, curbing market demand. In addition, skyrocketing labor costs in
China are also hampering supply. The cumulative effect of these factors
increases the likelihood that the global economic recession will continue.
Accordingly, the annual revenue of many enterprises in 2010 and 2011 will be
When determining asset allocation, investors are advised to avoid the impacts
of cyclical and structural factors. Sectors that will be heavily affected by the
de-leverage process and rising labor costs should be avoided. They include
the bulk commodity and raw material, aviation transportation and labor
intensive export-oriented manufacturing sectors.
Three types of assets are recommended
The first group includes enterprises
that supply necessary and popular commodities to lower to middle class
consumers. These enterprises are bound to benefit from the higher salaries
and increased buying power of these consumers. The second group includes
public utilities and related companies such as telecommunications operators,
equipment suppliers, and network optimization service providers that are
relatively unaffected by economic cycles. Blue-chips that are considerably
undervalued and have comparatively stable growth are the third type of assets
investors should consider buying.
For the long run, investors should pick up shares of companies that are bound
to benefit from China’s emerging trends. The next five year plan and the reform
of the income distribution system are the governments focal points for
economic restructuring. Two emerging trends are already shaping in because
of rising labor costs even without governments intervention. One is the rising
consumption in both scale and structure. The other is the substitution of capital
for labor and the ensuing generation of increased added value to goods and
services. The healthcare, consumer goods, telecommunications, technology
and capital goods sectors constitute the major lines for investment. Compared
to developed countries, these sectors make up the smallest proportion of the
entire market capitalization in China, and therefore have the greatest potential
for explosive growth.
Janet Shen can be contacted at FNCHN