The great fall of China?

14th June 2012

But there are an increasing number of stories suggesting that investors might do better to look elsewhere. Here is an article that posited China as the problem, not Greece. Some of the attacks are more pointed. This is one on China as a kleptocracy , which makes accusations of corruption. There are many articles on China's growth slowing down.

And the China Shanghai Composite Index, which now stands around 2,300, has shed nearly 500 points in the last twelve months. In the UK, original investors in one investment trust that was widely marketed to individuals two years ago have seen each £1 share fall to 73p.

Is the China story finished? Mindful Money put a number of specific points to James Weir, Asian Investment specialist at Guinness Asset Management. Here are his responses. Our questions are in bold.

 

The west is in recession or worse.  Will there remain a market for Chinese goods?

Yes. There will remain a market for manufactured goods although that may be less strong. But this will be more than offset by the growth from the Chinese consumer.

China has an undervalued currency. How will this affect the future?

The authorities are caught between two stools. If they let the currency appreciate, they would both increase the spending power of the population and increase China's power on the world economic stage. But were it to revalue, say by 15 per cent, it would be bad for the exporters which are a vital part of the economy. This would increase costs in Western economies which are already feeling pressures. The Chinese government can manipulate the currency in the way Western governments cannot. It has allowed it to appreciate slowly, especially against the dollar, since 2005. A sudden revaluation would benefit neither China nor the West

Much has been said about the "reshoring" phenomenon where manufacturing leaves China either to return to domestic firms or move elsewhere. Is this a media myth or reality?

China's industrial structure is changing. The perception of Chinese exports as cheap, low-end and nasty is no longer the case. It is aware that production of textiles or plastic flowers is expensive in terms of energy, water and pollution. It is now aware that there is a balance between environmental degradation and profits. If margins are not high enough, it is happy to export low end production elsewhere – Viet Nam, Burma are examples. The Chinese realise that they cannot compete in high-end manufacturing such as advanced electronics or top of the range automotive where the labour cost component is relatively low. China still struggles in many skills areas. Where we are moving to is not cutting edge or R&D heavy but neither is it clothes pegs.

There are many activities that I do not see the west doing. So reshoring is not as wide spread as the media might imply – and part of it is low-end work going to less developed Asian economies.

China is accused of poor corporate governance.  Do you agree?

There are accusations that some companies practice lower standards of corporate governance that are routinely corrupt. So this has become a live issue as Western trading partners are increasingly of their own anti-bribery legislation. The position of State Owned Enterprises (which are controlled by the government) remains significant, especially in banking. While they are increasingly behaving like private enterprise, they have to uphold the interests of the state. At the same time, private firms need to keep in with the government, which can cause strategy shifts – or worse.

One useful website for both institutional and private investors is www.webb-site.com where you can find a mass of corporate, legal and other information written from an Hong Kong perspective.

Transparency is improving. Companies are becoming more responsive to shareholders. But we are not there yet.

Taiwan is doing better. But South Korea is worse with more networks of cross ownership for investors to disentangle. In Asian terms, China is middle of the transparency table.

It is often said that Chinese firms and their large shareholders/executives keep profits rather than distribute them to other investors as dividends. Is there any truth in this?

Some. You are dealing with a very young corporate culture. Companies in Hong Kong are better as they are more used to shareholders and dividends. But there is some light even if the tunnel is long. The Central Huijin company which manages government stakes in companies has told banks to pay higher dividends. This should have a knock-on effect.

How easy is it to analyse Chinese companies?

Some companies are unloved for good reasons. They may have cash flow problems – some state enterprises only pay invoices once every six months so investors have to ensure firms can cope.

More vitally, companies may be corrupt, or form part of a kleptocracy which effectively steals from investors. Or at least, that is the feeling. The government is trying to root out corruption – the penalties are brutal including execution.

But there are red flags for investors, especially in "undervalued" companies which can excite some credulous share buyers.

 I am especially wary of Chinese firms which have reversed into US shell companies on Nasdaq as this avoids the need for a full prospectus.

A number promote bonds and other debt instruments via tax havens such as the Cayman Islands. The security, apparently assets in China, may be missing along the line. And not all State Owned Enterprises are safe.

There are so-called "asset injections" where a listed company buys an asset from a parent non-listed company at a good price to push up the share price overall. There has been a clampdown on this process. It is always a case of uttermost due diligence.


Chinese growth is slowing. Will investor interest wane?

The growth rate has to slow down – if only because at the previous rate, it would have become bigger than the world. It is mathematically impossible to continue at 10 per cent a year. The focus will change as China matures. Consumption is rising and the reform of financial services is starting. Last week, they began to liberalise interest rates. 

Insurance needs more companies and more competition. But China is a walled garden and the high rate of Chinese savings needs to find a home. Property is overdone, cash is negative after inflation leaving equities for which there is effectively a captive Chinese market. I am confident that investors will adjust their focus. Ultimately, it comes down to good companies which can deal with slowing growth.

 

More on Mindful Money:

Is the sun setting on China?

Should investors be worried by China's slow down?

With Weetabix in the bag, which iconic British brand will China snap up next?

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