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In harmony with slower China

Despite a fall in the blistering pace of growth and other problems, the reality is that China is still an attractive prospect

Here on the Asia desk, we are comfortable with the China story. There is no doubt that the market has been significantly de-rated over the past two years, as shown by its compelling valuation and earnings’ growth prospects relative to peers at this juncture. Recent events have only added to uncertainty and reticence among the investment community.

We would argue that political and economic worries are overdone and largely priced in and the market offers good value on a risk-reward basis. Our view is that any corrections, particularly those that are Western worldinduced, should be used as a buying opportunity.

Last month’s surprise interest rate hike means inflation pressures are building and signals that Beijing is concerned about the strong pace of economic growth and demonstrates its commitment to more sustainable, slightly slower growth. Food prices are a concern as they constitute more than 30 per cent of CPI, yet government officials can do little to control them with monetary policy. Core CPI (excluding food and energy) registered just 1.1 per cent in August.

Also, with wages rising in line with economic growth or the past decade, Chinese consumers are better able to manage rising food prices than most.

The subject of inflation often invokes Milton Friedman’s famous “monetary phenomenon” quote and investors are perplexed that buoyant credit and liquidity conditions have not translated into higher inflation in China.

The simple reason is that the velocity of money – the average frequency with which a unit of money is spent over a specific period of time – has fallen sharply, to its slowest pace in 10 years. Contrary to popular perception, more money is being safely deposited at the bank, not pumped into real estate or the stockmarket.

There has been a lot of concern that a currency war is imminent. However, the economic and political reality is at odds from the hysterical headlines we have been subjected to.

Looming mid-term US elections and a G20 meeting have provided a smokescreen for US treasury secretary Tim Geithner to postpone the release of the government’s semi-annual exchange rate policies report to Congress, a prerequisite to formally labelling China a currency manipulator.

First, there are no internationally agreed standards as to what constitutes a manipulation.

Second, the language of the document has been significantly weakened from a blanket export duty on Chinese goods to evaluating issues on a case-by-case basis.
Third, the non-partisan Congressional Research Service recently concluded that an undervalued renminbi “is expected to have no medium or long-run effect on aggregate US employment or unemployment”.

Most important, senior officials in both parties recognise the importance of the bilateral economic and strategic relationship and will not overreact. China is, by a huge margin, the fastestgrowing market for US goods. Over the past decade, US goods to China rose by 330 per cent versus 29 per cent for the rest of the world.

There has also been concern that the Chinese economy is slowing. This is the consensus response to China’s thirdquarter GDP (up by 9.6 per cent year-on-year) released at the end of October.

Certainly, there has been a deceleration from the double-digit rates of the past several quarters, due in large part to the gradual withdrawal of last year’s massive stimulus programme. However, domestic consumption and investment remain extremely healthy and, as we have stated for much of the year, Beijing will be far happier with high-single-digit growth as it embraces Hu Jintao’s stated policy objective of a “Harmonious Society”.

Craig Farley is investment manager in the Ashburton Asian equities team

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