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China points

Kira Nickerson Investment Matters

Currency is a key factor in investments at the moment, with all eyes following the various implications of a weak US dollar. Central to that is the China debate. For UK investors, it may seem that the battle between the US and China over the latter’s fixed rate to the dollar is moot but the fallout could have serious impact.

At the moment, China’s currency policy may add to the attractions of investing in the region but how long for is a question that needs to be addressed. Further out, this issue could conceivably lead to yet another global financial crisis, according to some economists. This makes it vital for UK investors to understand what is happening and what it may mean for their fund choices.

A weak dollar benefits export companies in the US and therefore its economy but as the dollar depreciates so too is China’s currency making its exports look even cheaper and making it hard for the US to compete.

On the surface, that does not seem such a bad thing for investors in China funds as they could benefit as the country’s companies thrive in such an environment. Being that it is at the expense of US firms also does not seem too great a concern and appears more political than an economic debate. But the situation is deeper than that and has far greater consequences for sterling-based investors.

Caxton FX currency market analyst Duncan Higgins says the fix to the declining dollar gives China an unfair advantage and the country is under pressure to change the situation.

Invesco Perpetual chief economist John Greenwood says there is no excuse for the country to keep the fixed peg it has had to the dollar since July 2008. “China is getting away with a lot in terms of its currency and it is cheaper than it should be. They need to get back to a revaluation track, appreciating the currency steadily,” he says.

While the US and the IMF have shown their concern and are pressuring for change, the Chinese authorities are holding fast and show no sign of conceding. Higgins says that while it is understandable that China has no wish to reverse the situation until its own economy is on firmer ground, the longer it goes on, the more impact the issue will have on global economies.

Ignis chief market economist Stuart Thomson says he is concerned about China’s stance. The move benefits the country’s exporters and, since export makes up almost 40 per cent of China’s GDP, in the short term, China is benefiting from the devalued currency. But the longer-term picture is not as rosy and Thomson believes it is creating another bubble and heightened global market volatility.

“The longer China leaves it currency fixed to the dollar or delays appreciation, the more likely markets will be out of line with fundamentals, which could lead to an almighty crisis,” he says. Although it creates a short-term competitive advantage for Chinese industry, it is creating an unbalanced structure in China with a misallocation of capital. Thomson says “It is an accident waiting to happen but you can’t tell when it will happen.”

China’s investment opportunities are undeniably attractive, drawing UK investors into the story. Certainly, it has many compelling aspects. Its GDP is forecast to grow at 8 per cent this year, infrastructure spend is high, government support is strong, retail sales in the region are improving and the country has big trade and current account surpluses and is building its reserves. But these latter points are indicative of China’s currency being undervalued, says Greenwood.

Schroders Chinese equity fund manager Laura Luo says there are many positive ways that Chinese authorities have aided the region’s recovery so far but they may have gone too far injecting liquidity into the system.

She says: “The extraordinary turn-round in the Chinese economy is now raising concerns about budding asset bubbles and inflation, leading to talk about when the authorities will unwind such ultra-loose monetary policies. While this is probably somewhat premature, we believe that this delicate balance to keep economic growth on a sustainable path is likely to dominate the direction of Chinese equities in 2010, creating periods of increased volatility,” she says.

Thomson compares buying China at the moment to picking up tacks in front of a steamroller, adding that it is all about timing. The short-term benefits may be there but for how long, he questions.

He says: “The imbalances there are unsustainable but there is no indication when it will tip over. When it does, it won’t be minor. It will have an important impact on global financial markets when it does come to a head.”

So what is the solution to the increasingly heated debate? It appears that there is no easy answer other than that something has to happen sooner rather than later. If China was to allow its currency to appreciate, how fast it happens is another serious concern.

Higgins says: “It is a balancing act. We are not looking for any sudden movements here. If that was to happen, it could destabilise the global economy when recovery is already at a fledging stage.”

Schroders ISF global managed currency fund manager Clive Dennis says the China issue is not the only one, with other developing countries implementing capital controls to ensure their currencies don’t appreciate too quickly. All this has led to increased volatility in global currencies and he does not believe that it will go away any time soon.

“We believe it is a trend which is likely only to intensify from this point as global authorities tackle the issue of unwinding monetary and fiscal policies implemented during the credit crisis,” he says.

With that in mind, the currency implications and denomination of investors’ share classes in funds will only become more important for advisers.
Currency issues and plays have gone from being a background noise for fund investors to an active consideration.

Dennis says: “With the global role of major currencies such as the US dollar likely to change over the coming years, there is a significant opportunity for investors to benefit from these shifts. Moreover, with inflation likely to rise again, threatening individuals’ global purchasing power, investors have rarely had more reason to consider their currency exposure.”


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