China outlook positive, says CLSA strategist

Even a worst-case scenario will not alter the course of the Chinese juggernaut, says Andy Rothman.
Andy Rothman, CLSAÆs China macro strategist, did his best to dispel gloom on ChinaÆs possible over-heating and exposure to a US slowdown on Tuesday, the second day of the annual CLSA forum in Hong Kong.

Rothman highlighted improvements in both the real economy, and far-reaching political moves to establish a æharmonious societyÆ on the eve of the 17th Party Congress later this year. ôThe Chinese economy is not growing too fast," he says. "The tightening measures we have seen are just token measures. ChinaÆs exposure to a US slowdown is diminished by its diverse export market and low contribution of net exports to GDP.ö

Rothman explains the last point by saying that while exports represent some 36% of ChinaÆs GDP, net exports only represent 7% of GDP. Net exports are calculated by stripping out the value of the import components that go into making export products.

By CLSAÆs own calculations, China's economy grew at a rate of 8%-9% in 2006 and will grow at 9%-10% this year as well as next year. A US recession would knock 50 basis points off that growth, while a global recession would knock 200 basis points off.

Rothman builds a picture of an economy which is still exporting very low value items. He quotes trade minister Bo Xilai as saying that for every $700 computer that China exports, only $15 goes to the Chinese manufacturer.

The Apple iPhone is made in China, but most other high-value items are imported into China before being assembled there.

He estimates that because of ChinaÆs niche at the low end of the value chain, it will be a beneficiary of foreign consumers switching to cheaper goods in the event of a slowdown.

ChinaÆs strength in this sector is astonishing. Between 1997 and 2005, prices of goods exported from China to the US fell by an average of 1.6% per year. Despite this, manufacturers of some of the largest categories of goods sent to the US saw their profits climb steeply, with year-on-year profits up more than 30%. Overall industrial profits increased 43%.

Optimists like Rothman say that this is due to manufacturers making substantial gains in efficiency and labour productivity. Pessimists would say that a proportion of these profits (one banker estimates around 20%) have come from companies investing in the stockmarket, which has doubled this year.

In terms of diversity, the European Union overtook the US as ChinaÆs single biggest export destination in the first half of 2007 (around 29% versus 28%). But exports to Africa, Latin America and the Middle East have seen the biggest growth, from around 5% in 1995 to around 16% currently. Interestingly, exports to Japan have come down from 20% in 1995 to just over 10% today.

In terms of export growth, the EU contributed 21%, while the US contributed just 14% in the first half of this year.

Referring to the tightening measures introduced by the Chinese government, Rothman says they were mainly directed at gradually increasing the cost of capital. Excessively cheap capital was leading to non-performing loans and over-investment, he says.

As for inflation, which saw the consumer price index (CPI) reach a record 6.5% in August, Rothman puts it down to food price inflation, in particular pork and poultry. Non-food CPI rose by less than 1% in August. ôAfter disease hit the pig and poultry population, it took Chinese breeders a while to replenish their stocks,ö he says.

Returning to the question of ChinaÆs exposure to the US, Rothman says that fixed asset investment (FAI), growing 25% year-on-year, will continue to help drive the economy. Rothman sees investment (including property and manufacturing) and consumption as the main drivers of the Chinese economy û not trade.

Rothman is also bullish on property, which is part of FAI. ôWhile property prices are going up strongly, they are lagging personal income growth, apart from in Shanghai.ö

As for the æharmonious societyÆ that the Chinese leadership is proposing to build up, Rothman is convinced that it offers a serious blueprint for major pollution and poverty alleviation measures. ôGovernment officials are having their bonuses linked to improvements in energy efficiency and pollution reduction,ö he says, noting that pollution has been an important contributor to social unrest. He also says the government is committed to opening health clinics in every township.

What Rothman does not say is that the æharmonious societyÆ project will also constitute a great way for the government to pump-prime the economy in the event of weakening external demand. The leadership is not leaving anything to chance.
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