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Despite Rate Cut, Investors Focus on China for Long Term

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Last week’s interest rate cut by China’s Central Bank, the third of its kind since last November, sent Asian stocks soaring and reassured investors that the Chinese authorities are concerned about the rate of growth of Asia’s largest economy.

Economists forecast a 7% growth rate for China this year, a figure that’s much lower than in previous years, but still far better than many other economies around the world. That’s why investors, despite having some concerns about the Chinese economy and market in the short- and medium-term, are bullish on China in the longer-term. Here are some of the trends they see, both current and future:

Rajeev De Mello, head of Asian fixed income, Schroders:

“China is in the process of reforming its financial sector at a very rapid pace. As the rate cut was announced, banks were given more leeway to compete on deposit rates, which will bring more deposits back into the banking system from the less regulated non-banks. A deposit insurance was also introduced to help smaller banks that are more exposed to outflows during periods of uncertainty. China is also addressing the imbalance between central and local government financing.

Reforms are often not popular and can slow growth in the short-term. However, correct reforms will lead to higher, longer-term growth, which should be positive for investments. And longer-term economic drivers include China’s huge internal market; a significant manufacturing experience that can be developed further and efforts by Chinese companies to move into higher value sectors and de-emphasize shoes, clothing and cheap plastics.

In the short term, actively easing monetary policy should be positive for government bonds. Over the past year, Chinese onshore bonds, which are the world 3rd largest bond market, have returned 8.4% (in local currency terms) which is the second highest return after India (14.4%). We also believe that the Chinese currency will remain stable against the US dollar during this year.”   Edmund Harriss, portfolio manager, Guinness Atkinson Asset Management: “China’s policy to shift toward consumption is slower, but will lead to more profitable and sustainable growth, and slower growth under the new model is better for investors, better for everybody.  

Over the next 15 to 20 years, China also plans to increase outbound investment and improve trade links, to engage more fully with the international financial system through the internationalization of its currency. Interest rates are below the nominal economic growth rate and, to be consistent with stated policy, the Peoples Bank of China probably feels rates are low enough. 

They will look to see how this is passed through and are likely now to focus on tactical measures to manage liquidity.  Tighter liquidity/ slower money supply pushes up the cost of money and slows growth.  With required reserve ratios for the Big Four banks still at 18.5% (compared to 7% pre-2008) there is still considerable room to manage this if needed.”    

Anthony Criscuolo, financial advisor, Palisades Hudson Asset Management:

“The Chinese financial system is in need of overall reform and the attempts in that direction are positive, but our overall outlook is certainly longer-term focused. We think there will be a lot of volatility in the short- and medium-term, brought on by the government’s efforts to spur growth and a subsequent, rapid rise in the Chinese equity market, driven largely by speculation from Mainland China and local investors in the A Shares market.

So we think it’s very important for investors to remain focused on the long-term and not to try to time these short-term rate cuts and other measures. China’s per capita GDP is comparable to the U.S’s in the 1950s, so there is tremendous growth opportunity that will be driven by trends like urbanization and the tremendous rise in education levels, among others. As investors, we’re focused on the healthcare, education and consumer cyclical sectors. Fredrick Jiang, portfolio manager, Ivy Emerging Markets Equity Fund:

“China has run out of the so called ‘demography dividend’ as its labor force has reached its peak. However, as China churns out more college graduates than any other country in the world, China should be able to capitalize on its ‘talent dividends’ in the coming decades.

Technology and urbanization – the rate of which is still way below developed market countries. – will drive growth in the medium-term, and China’s infrastructure per capita and capital per capita are still a fraction of those of OECD countries, so infrastructure build-out and capital formation should continue to play an important role in growth, though not as much as before.

In the long-term, the technology, healthcare, internet and consumer sectors should be secular investment theme. As for interest rates, there may be another cut this year, though there isn’t much room left. That said, the required reserved ratio (RRR) for commercial banks can still be cut much more and I can see it declining from the current 18.5% to 10% in two years time.”

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