Some say the East is the new West and that emerging markets, chiefly China, will be the best home for investment growth in coming years.
While others say issues surrounding inflation, corporate governance and the role of the State will erupt in these nations sooner rather than later and for that reason China is not the one-way success story bulls would have us believe.
In the interest of giving both bulls and bears the chance to air their case, Portfolio Adviser asked two economists out in Hong Kong their views on some of the key concerns in China today.
Dependency on exports
China’s dependency on exports is an important factor to gauge because with anaemic growth in the developed world, demand for the goods they export is dwindling.
Bull, Andy Rothman macro strategist at CLSA, said:
“The Chinese economy is even less dependent on exports than it was last time there was a global economic slowdown [2008[.
“It’s a misconception that China is export-led, when actually, things ‘made in China’ are ‘assembled in China’, with not much value added.”
Rothman used the example of an iPad, which is put together in China, and pointed out that only 2% of the profits from that product remained in China, because the components and technology are brought in from the US.
Nevertheless, the ‘assembling’ of products in China requires a workforce that is in turn dependent on the appetite for those exported goods in the developed world.
Bear, Jim Walker founder of Asianomics, said:
“Low liquidity and low real interest rates do not help and China still relies on world economic growth. When people tell you emerging markets are the answer to all your problems, don’t believe them.
“Purchasing Managers’ Indices are softening and exports are of no use at all at this point in time.”
Inflation
Chinese inflation has been in an upward trend since the financial crisis when the government pumped vast amounts of money into the economy to prop it up during a period of lean western demand. Some sectors have seen prices balloon more than others, with property the chief area of concern.
Bull, said:
“Income growth mitigates the Consumer Prices Index (CPI) measure of inflation and drives spending. Chinese CPI is 6% while income growth is 7% or 12% (countryside vs. city).
“Companies can handle 15% wage growth per year because cost-cutting and productivity are higher.”
Bear, said:
“GDP grew at 8% through most of the 2000s, but has only been able to get the same numbers through vastly pumping money into the system in the last three years.
"CPI is a very poor indicator of the true level of growth. Reserve Ratio Requirements have been unable to control the increase in credit in the overall system. It’s going to be an inflationary bust.
“Fixed asset investment, credit growth and asset prices are the three things to look at for true inflation and they are all better indicators of economies getting out of control price wise.”
Consumption
At the opposite end of export dependence is the level of consumption. The “consumer story” has been lauded as a great reason to invest in China. Supporters of it say that as workers migrate from the countryside and wages increase, more money will be spent on consumer staples.
Bull, said:
“Chinese consumers were not freaked out by the global slowdown, slowed down a bit, but not that much.”
Bear, said:
“Consumption has gone from 45% of GDP in 1998 to 32% of GDP in the past ten years.
“Consumption doesn’t drive growth. You can’t consume anything that hasn’t been produced. Production precedes consumption. If you don’t have production growth, you can’t have consumption growth.”
Walker added that there is a small minority of ‘haves’ in China who buy luxury brands as a conspicuous display of their wealth and so investing in multi-national western brands is the best way to access the nation’s ‘consumer story’.
Hard or soft landing?
Most people agree the development and growth of China cannot continue at the same pace it has been forever. But while some insist the state have the means to control how and when the growth slows, others say it is headed for a much harder landing.
Bull, said:
“There’s going to be a soft landing or not much of a landing at all.
“The Chinese manufacturing sector is doing well. Everything is slowing down and we’ve gone through the boom period. That doesn’t mean everything is going to crash, but it’s going to slow down.
Bear, said:
“It will be a hard landing, when have you ever seen a soft landing? Our sister company Forensic Asia Research look at crisis countries and use an index where the critical number is six. Anything above it is very stressed in corporate terms.
“Great news for Asia is that a lot of companies have got very sound financial scores due to cashflow.
“China and India, currently score around 5.7 – both are vulnerable to higher interest rates and lower growth and they are going to get both over the next 12 months.
“I don’t believe in soft landing you either have no landing or a hard landing.”
Walker predicted Chinese GDP would be 7% or 8% for this year and after that would slow dramatically to somewhere between 0% and 3% in 2012.
