CHINA WILL CONTINUE TO DANCE TO THE MARKETS TUNE / THE FINANCIAL TIMES ( VERY HIGHLY RECOMMENDED READING )

China will continue to dance to the markets tune

By Anthony Bolton

Published: March 7 2011 14:05

Almost a year after I moved to Hong Kong to run a China investment fund, I am struck by a shift in the mood music. It is as if, unable to hold more than one thought in their minds at a time, investors have displaced their enthusiasm for the Chinese growth story with concerns about inflation, currency tensions and political uncertainty.


The rotation from emerging to developed markets has been exacerbated, and may be prolonged, by the disturbances in north Africa and the Middle East. The impact of a higher oil price might be greater in the more energy-intensive economies of the emerging world than in the developed markets that have become more energy efficient over the years.

The worries of the market are never wholly without foundation and it is a foolish investor who dismisses them. But, having reappraised my bullishness on markets in general and China in particular, I am not yet ready to abandon my optimism.


The recent increase in the People’s Bank of China’s lending rate, the third since October, highlighted investors’ concerns that credit expansion is too fast, that inflation is too high and that the measures the government needs to take will impose a hard landing on the Chinese economy and so dent global growth as a whole.


Credit growth was strong last year, at maybe more than 20 per cent once off-balance-sheet loans and the other ways in which banks get around controls are taken into consideration. I expect credit to slow this year but that will not prevent growth being relatively strong compared with the developed world.


I think that all emerging markets, China included, will have to get used to structurally higher inflation, but it should be remembered that Chinese authorities have greater powers than in other emerging markets to control prices.
By edict, the government can and does impose controls on utilities, energy and food. It would be wrong to underestimate what the Chinese can do on a one- to two-year view.


China’s inflation is being driven very largely by rising food prices. Excluding these, inflationary pressures are actually relatively mild so while I expect further increases in interest rates and tightening of the banks’ reserve requirements, it would be surprising if the moves were other than slow and steady. That is not how the Chinese go about things.


A second concern is bad debts. Again, I am less worried about these than are some other China watchers. The main concerns are at the local government level, where finances are not as strong as they might be, much has been spent on infrastructure and some loans are under water. Again, however, the government can do a lot to alleviate the problem, moving money from the centre to the regions and changing the way that local government is funded, through, for example, property taxes rather than land sales.

Currency tensions are not good news and relations between China and the US on this issue have deteriorated. I hope that the recent presidential visit might help but this is an area I watch very carefully. Similarly, political tensions cannot be disregarded. I am more concerned about Korea in this respect than China itself and I think that markets are somewhat complacent about the fact that, to date, the South has acted with restraint.


Within China, a bigger issue surrounds the social challenges arising from the epochal shift of the world’s most populous nation from a manufacturing to a services-based economy with all the associated retraining and upheaval of individuals and their families. Jobs will come and others will go and this will create tensions.


For now, the new middle class is happy with its new cars, consumer goods and apartments. Further out, increasing affluence will bring a desire for more freedom. How the government adapts to this will be critical.


From a purely investment perspective, political risk is greater than I was used to when running money in the UK and Europe. Policy risk is more significant for, just as the government can control inflation by fixing prices, it can change the ground rules for a company or industry in a way that could not happen in the west. Sometimes measures can come completely out of the blue and, as an investor, you have to adapt to this.


In other ways, however, the state can act in an impressively pragmatic way. There is nothing capricious or unplanned about the way in which new measures are often trialled in two or three cities or regions before being rolled out nationally. If the measure works it is adopted; if not, it is simply dropped.

Hong Kong is where this very different system collides with the west, the epicentre where the tectonic plates of China and the rest of the world rub up against each other. Hong Kong imports US policy through its currency and interest rates but is most influenced by China in terms of trade and culture. It is an unstable place, but in a good way, and the mood music here is still harmonious.


Anthony Bolton is president, investments at Fidelity International


Copyright The Financial Times Limited 2011