In April, China’s rampant GDP growth and signs of rising inflation caused rumours of the first interest rate increase in several years, bringing back bad memories of hyperinflation in 1998 and 1994. Investors promptly lost all optimism over China, and markets dropped almost 10 per cent in April and May. At times like this, perspective is essential - China’s 3.8 per cent increase in inflation in April is far less than the 25 per cent jump that presaged earlier disasters.
Inflation is also narrowly focused, mainly on food prices that are stabilising. It is encouraging that China’s central bank, which now has experience managing this problem, has taken steps to address the issue early. It has begun to constrain lending to certain industries such as motors and aluminium. It is likely to lift interest rates by only a small amount.
As the dust settles, investors will likely see most of the same reasons they became so excited in the first place. Return on equity – which inevitably translates into higher share prices over time – is rising for many companies, driven by stronger profitability and better capital discipline as companies learn to sweat their assets.
Corporate governance is making a slow improvement. However, many firms still fail to structure their balance sheets as well as they could and use dilutive equity liberally rather than debt – but this should change over time.
The momentum behind growth and better margins, particularly in China, remains resilient. Its average import tariffs are lower than any other country in the region – around 9 per cent compared with 32 per cent in India – and the economy’s openness will encourage competitiveness in the right areas as well as growth.
Seventeen per cent of China’s exports are to Japan, which positions it to profit from what appears to be a gathering turnaround in the world’s second largest economy. Rising consumption, supported by higher incomes, is forecast to make up for the moderation expected in capital investment and experts.
The good news in the region is not entirely restricted to China: Korean consumers are climbing out of the doldrums; Malaysia and Singapore are also making a domestic recovery; and Hong Kong’s economy has been given a major hand-up by its Common Economic Partnership Agreement with the mainland.
Mark Breedon, Asian equity fund manager, Investec AM
