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Written in the Sars

Until recently, China&#39s reputation as one of the world&#39s most promising investment regions had been growing almost as fast as its economy.

But the emergence of Sars and the under-reporting of cases in Beijing has shaken the belief that China is ready to become one of the powerhouses in the global economy.

Is this fair? Should IFAs shun China in favour of other developing economies?

Hargreaves Lansdown investment manager Ben Years-ley says: “China is one of the big untapped growth areas but you would not put much of your portfolio there. After Sars, how much do you trust the authorities? It is interesting but there are a lot of concerns.”

One of them is the banking sector. Most global and China fund managers agree that Chinese banks need restructuring in much the same way as banks in Japan have been forced to restructure in the past few years. For example, one fund manager says a bank executive told him it was normal to offer homeloans on an income multiple of 10.

Pension liabilities are also a problem, running into hundreds of billions of dollars.

But despite these difficulties, the economy remains buoyant. In the first quarter of the year, GDP growth topped 9 per cent, driven by strong exports and domestic dem-and. Although Sars, combined with seasonal factors, is likely to reduce this to 6 per cent during the second quarter, many fund groups expect growth to hit 7 per cent for the year. Growth projections for many European countries in comparison stand at just 1-2 per cent.

Fund managers say it will not be long before China&#39s growth will be reflected in the indices covering the region. Gartmore China opportunities fund manager Philip Ehrmann says: “In the Pacific exc Japan index, Australia, with a population of just 20 million, has a weighting of 41.1 per cent. China&#39s weighting is 2.1 per cent but it has a population of 1.3 billion. It is not hard to see where the weightings will go in the future.”

Ehrmann believes that in 12-18 months, China will comprise around four times that weighting, with Sars only causing a short-term disruption to trade, movement of goods and travel.

In fact, he is encouraged by the fact that the Chinese authorities sacked both the health minister and the mayor of Beijing when they discovered that the number of cases was much higher than previously announced.

In Ehrmann&#39s view, this shows that China&#39s attitude towards transparency and openness has changed for the better. However, until the World Health Organi-sation declares China safe, Sars will remain a bane of the economy.

The other by-product of Sars has been the mass selling of shares, which has generated considerable discounts. Fund managers see telecoms and utilities as core bets but prefer H shares (Chinese firms listed in Hong Kong) due to lingering fears surrounding the former&#39s accoun-ting practices, regulation and corporate governance.

Instances of erratic corporate behaviour include a mobile phone battery manufacturer which had been listed on the Chinese stock exch-ange for just six months before it bought a car plant – hardly what investors were expecting.

Nevertheless, China rem-ains one of the lowest-cost manufacturing regions in the world and continues to steal market share from comp-eting countries.

The main reason for this success is that China remains a very poor country. In Shang-hai, for instance, the average GDP per capita is just £3,000. The majority of the rest of the population is barely subsisting. However, the highestspending tourists in Hong Kong – splashing out the equivalent of £400 a day on average – are not American or British but Chinese.

First State Investments Asia Pacific senior portfolio manager Alistair Thompson says: “Domestic demand in China has been very robust but the big positive has been this wealth effect. We still tread very cautiously, though. China before Sars had att-racted a phenomenal amount of direct investment. This is risky because China blows hot and cold. Sars may temper this, though, which is good because it was getting out of hand. But it is a country that cannot be ignored.”

In fact, around 15 per cent of Thompson&#39s fund has exposure to China. Global funds such as his are fast becoming the choice of IFAs who prefer to delegate the degree of exposure to experts in the region.

Bates Investment Services head of investments James Dalby says: “Generating interest in China among UK inv-estors is very difficult but it certainly should should be part of any portfolio, preferably with exposure determined by the manager of a global fund. I would not pick a specific China fund.”

There are only a handful of pure China funds – some are split between China and Hong Kong, which are generally reg-arded as lower risk. But even these “safer” funds are unlikely to top many buy lists as fears increase about the Chinese economy overheating.

According to Invesco GT Greater China opportunities fund manager Billy Chan, however, the Chinese government is already taking pre-emptive measures to dampen down the economy but he believes there are potential problems with industrial overcapacity.

Chan&#39s view arguably emb-odies the difficulty with China – the positives are many but often they are followed by a major caveat. Nevertheless, it is an area rapidly becoming impossible to ignore.

Its economy is outstripping any in the Asia region, its export competitiveness rem-ains robust, its market is trading at a discount relative to its peers and domestic demand is booming. Once its problems are ironed out, it could well emerge as the global powerhouse it has long threatened to become.

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