The Chinese story has started to appear as a major blip on many people's radar as the overall implic...
The Chinese story has started to appear as a major blip on many people's radar as the overall implications are felt world-wide. As the year 2004 draws to a close, it is good to glance back and realise real GDP growth for the Asian region has been impressively over 5% and set to continue next year. The star performer is expected to be China once again with a projection of 8%-10% growth for 2005. However, in order for us to go forward, we must understand the recent past and certain issues.
The first issue - extremely low interest rates - has fuelled a revival in the fortunes of Asia and helped the region recover from the financial meltdown of the 1990s. As a result, the prices of property have rocketed on readily available cheap finance. Conversations on this subject always end on the topic of Chinese interest rates and the revaluation of the renminbi. Without a doubt, the Chinese authorities will make a move on both of these when the world least expects it. Clearly, Asia is facing a different path on the interest rate front compared to Western countries.
The second issue is the staggeringly high oil prices over the majority of this year and, in turn, the implications for the world. Bear in mind the US is not in any way as dependent on oil as in the 1970s but most of Asia, with the possible exception of Indonesia and Malaysia, still relies heavily on oil imports. The colossal industrial machine of China has begun to gain an appetite for consuming crude oil at an ever-increasing rate and now is the second largest consumer of oil. It is not impossible to imagine a situation in the next couple of decades where the US and China both fiercely compete for the same oil reserves. The growing demand has and will continue to outstrip supply, pointing to a higher longer-term oil price and, consequently, the energy sector has been one of the best performing on the year.
In fact, a similar situation can be seen in most commodities such as steel, coal, copper and as a result, the prices are testing all time highs. In turn, the indices for countries such as Australia, New Zealand and Indonesia are also hitting long-term highs. The underlying companies and currencies are themselves also benefiting from the sweet spot of considerable Chinese demand. In a lot of the situations, investors focus too much on the Chinese story as most of Asia, Europe and even the US have all managed to experience some form of growth connected with China. The long-suffering Japanese market has finally surfaced from almost two decades of deflation and a large part of the growth has been linked to Asia. Hence, one can conclude Japan has passed the worst stage of the deflationary spiral and moved into a phase of mild recovery.
The chink in the Chinese armour is the rising cost pressure of raw materials filtering through the supply system. The cost pressure will in turn squeeze current comfortable profit margins and, as a result, force more efficient management of companies and industries. There is no harm in realistic inflation on raw materials but the jump in prices will haunt companies for the next couple of years. There is also the thorny issue of the banking system in China in desperate need of major reforms similar to the restructuring in Japan. The Chinese banking system is virtually insolvent, as bad debts stand at roughly 40%, the highest level in the world. The banks have mainly been vehicles for the government to throw money into public projects and hence the whole psychology of banking and risk assessment will need to change.
The key question is, where do we go from here? It has become quite evident that many investors and companies have made lots of money recently on investment themes in Asia. However, the next stage of growth will be more selective and a rising tide will not raise all boats. It is also important to realise that China is still a very poor rural economy with a per-capita GDP of only US$1,000 and the economy is still in the early stage of industrialisation. Over 60% of the population are based in the rural inland provinces and as yet, have not participated in this bout of spectacular growth. The same rural provinces exhibit relatively high unemployment and house many inefficient state industries. There are a number of obstacles (mentioned above) to further industrialisation but, actually, the first stage is now over, it is simply the end of the beginning. Hence, as an investment house, we are more optimistic on the opportunities within Asia and in turn the benefits of Chinese economic growth through the next generation.
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