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Chinese checkers

This month’s Beijing Olympics are the culmination of the transformation of China from an authoritarian communist state reliant on collective farming into a key player in the global economy, a process that began with the initiation of economic reforms in 1979.

Since then, China has become one of the world’s fastest growing economies and one of the top exporters. It is attracting record amounts of foreign investment and is itself investing vast sums abroad. It is expected to continue to enjoy rapid economic growth in the years to come and could become the world’s biggest economy within a couple of decades through what has been dubbed by some commentators as the second industrial revolution.

China faces a number of challenges, including an inefficient banking system, over-reliance on exports, social unrest and growing inflationary pressures. Also as a member of the World Trade Organisation, it must open its doors to outside competition. Relations with its trading partners have also come under strain because of its huge trade surplus and the piracy of goods.

China’s growth has been slowing so far this year, reflecting the impact of declining net exports and the worst winter weather in 50 years. Inflation has been a problem, largely because of spiralling food prices. Government policy has been very restrictive as a result.

In an attempt to restrain the economy, the People’s Bank of China announced in June that the reserve requirement ratio would rise by 100 basis points to 17.5 per cent. The RRR is the reserve that the PBC requires its member banks to hold with it, in cash or other liquid assets. This is the fifth increase in 2008 and the 15th since the beginning of 2007. Key lending rates also rose.

More recently, however, inflation has eased to around 7 per cent which allows the authorities to move to a less restrictive stance and also to begin to address structural issues such as price controls on energy.

China recently increased the domestic retail prices of petrol, diesel and electricity while at the same time freezing thermal coal prices. The real effect of this will be to increase the retail price of petrol by about 18 per cent in an attempt to reduce demand and ultimately restrain inflation.

However, China’s economy continues to be a concern to worldwide policymakers, most notably the US. On the one hand, US consumers and investors have benefited greatly from China’s rapid economic growth but the surge of exports to the US has put competitive pressures on various US industries.

Concerns have also been raised over China’s rising demand for energy and raw materials and the impact on world prices for such commodities.

China’s rapid quest to industrialise will prove beneficial for those who invest in companies with exposure to Chinese infrastructure spend. For example, our UK equity portfolios have significant exposure to iron ore mining stocks. Contract negotiations between miners and China’s biggest steel producer, Baosteel, saw the miners secure a substantial increase in the price of iron ore which reflects China’s insatiable hunger for raw materials.

Another example along this theme is seen within our European equity portfolios where we have invested in European steel producers which have benefited from China’s insatiable demand for steel. Aegon’s European equities desk believes that the fundamentals for the steel industry are stronger than market expectations.

Despite difficult economic conditions, China’s demand for commodities continues to be robust, with increased urbanisation and the infrastructure that goes with it, such as power stations and transport systems, continuing unabated. We think there will continue to be opportunities to benefit from investing in companies with exposure to Chinese infrastructure spend.

Innes McKeand is head of equities at Aegon Asset Management

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