The Chinese economy has had strong growth over the past few years. China"s entry into the World Trad...
The Chinese economy has had strong growth over the past few years. China"s entry into the World Trade Organisation (WTO) has seen an increase in the flow of money to the country. It also remains an important place for companies to outsource their manufacturing operations.
But, there are now concerns that the economy is becoming overheated. The central bank is set to raise interest rates and has begun to loosen certain exchange control regulations to allow more money to be taken out of the country.
According to Michael Watt, director of Pacific Investment Trusts at Henderson Global Investors, China"s entry into the WTO has triggered strong growth and there has been a huge increase in direct foreign investment.
China has become a major powerhouse for the global manufacturing industry. The country has benefited from companies outsourcing their manufacturing plants in China.
However, there are now concerns this growth could lead to overcapacity and the central bank is set to raise interest rates to try and slow things down.
Omar Negyal, fund manager at F&C, says: "The fact that the central bank has initiated a slowdown is negative. Although there has been no increase in inflation, the growth has been positive. So far it has not done anything but force people to go out and get loans before they get too difficult to obtain. In order for growth to slow down the bank will have to do more such as raising interest rates."
However, Watt believes the bank should raise interest rates because the property market could be overheating. This could in turn cool things down.
The Chinese government has also been looking at ways to get rid of excess liquidity. The currency is currently undervalued.
Negyal says the government should relax its controls, making it legal for money to flow out of China to relieve liquidity. The currency is pegged and there are strict controls of what one can take out the country.
Recently the Chinese government has set up a free trade agreement with Hong Kong. The Closer Economic Partnership Arrangement (Cepa) has opened up links between China and Hong Kong allowing Chinese individuals to travel to Hong Kong, where before they were only allowed to do so on package tours.
There could be other possible changes in regulations to help increase the flow of money out of the country. It is also a possibility that the Chinese government may allow insurance companies to begin buying overseas bonds. In addition, qualified domestic Chinese institutional investors could soon be allowed to invest in Hong Kong.
Negyal says the government should relax exchange controls. However, Negyal warns although this may be positive for Hong Kong, it may be negative for Shanghai as Hong Kong shares trade at a 30% discount to Shanghai"s. There are concerns that Chinese institutional investors would only invest in the Hong Kong market and take considerable money out of Shanghai.
Watt disagrees. He says: "Exchange controls should not be lifted. There are still lots of issues that need to be addressed in the banking industry. China does not have a very sophisticated banking business and until it is financially together, the exchange controls should not be lifted. There should be enough money floating out of the country to make liquidity not a problem."
Another concern regarding China is deflation. Negyal says: "Inflation has only just recently become positive and there is a possibility China could slip back into deflation, if there is overcapacity in the manufacturing sector."
Watt does not agree, although he does not foresee inflation. He says the problem that is causing prices to stabilise and fall is competitive pressure within the economy. It is positive as long as China is able to make money at these pricing levels.
Watt says: "China is also beginning to become a consumer society especially in the eastern coastal areas. There has also been some level of domestic consumer recovery in China. Chinese monthly car sales are stronger as is the property market."
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