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China choices

At a time when most of the West is already in recession, China’s economy continues to expand. The main reason to be optimistic about the Chinese economy is the flex-ibility and determination of the authorities to take action to support it.

With government debt still well below 20 per cent of GDP, the central authorities have plenty of scope to expand their fiscal policies to encourage a recovery in economic growth. We expect spending on infrastructure development, from road and rail projects to water and power systems, to be increased markedly.

The government can also make changes in its monetary policy to encourage growth. These would include a reduction in tax and interest rates and a lowering of the banks’ reserve requirements to encourage lending.

Indeed, China could emerge from the current crisis in an even stronger position than it was before. It has huge reserves of cash to increase its expenditure on education and research and development as well as on physical infrastructure development.

All this should boost the nation’s productivity in the coming years. The global slowdown has already ensured that inflation is no longer a problem and deflated what had threatened to become a worrying real estate bubble. Falling demand has led to dramatic falls in the cost of air freight and shipping, to the benefit of many companies. Labour costs, which had been rising, have also moderated, improving the country’s competitive position.

China’s robust financial situation and its strong banking system is enabling some of its major companies to expand internationally, making offers for foreign businesses. We have already seen Chinalco attempt to take a big stake in Rio Tinto and other companies are looking to expand in the automotive, energy, food, electronics and textiles areas.

The recent release of stronger than expected investment in fixed assets supports our positive view on infrastructure development. In January and February, fixed asset invest-ment grew by 26.5 per cent year on year, above expect-ations of 20 per cent growth.

The growth is attributable to the economic stimulus package, which has boosted investment. Infrastructure projects were started faster than expected after the central government’s call for action in November 2008 and investment in central government projects rose by 40 per cent.

In particular, investment grew rapidly in railway development, cement and coal projects related to infrastructure construction, nonferrous projects and power develop-ment. We expect this to partially offset the damage from export deterioration.

In our view, the severe falls of the Chinese equity market during the 12 months from the end of October 2007 mean that share prices now look particularly attractive and more than reflect the slowdown in the economy.

We are using the low valuation of Chinese equities to build positions in stocks which are likely to benefit most from the government support to the economy. This includes companies involved in infrastructure development. We are also upbeat on the outlook for the consumer discretionary sector, where we expect reductions in tax and interest rates to encourage spending, and commodities, particularly gold.

We are more cautious on the consumer staples sector, where we believe share prices are overvalued and could be vulnerable to earnings’ downgrades.

Ian Pascal is marketing director at Baring Asset Management


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