20th February 2014
Philip Ehrmann, manager of the Jupiter China Fund, says critics who worry that China’s rapid economic expansion could come to a crashing halt underestimate the reforming zeal of the new Chinese administration.
Ehrmann issued the note this week, arguably in response to a BBC 2 programme on China presented by the BBC business editor Robert Peston, and summerised in his blog here.
Peston warned there was a risk of a calamitous crash. But Ehrmann begs to differ saying the administration is alive to the problem.
“The naysayers of China’s economic boom are surfacing again, warning all those who care to listen that the country’s debt-fuelled growth will eventually prove its undoing. Their concerns are in my view misplaced. The new Chinese administration has made quite clear that it is engaging in meaningful reform to manage the excesses, intended or otherwise, that have been building up in the economy.
“Foremost among these excesses identified by the authorities has been the issue of misallocation of capital and the imbalances caused by funding long term major infrastructure programs with short term lending. Far from ignoring the issue, China’s administration is tackling it head on”.
Ehrmann agrees that China has seen loan growth reach unprecedented levels in the last few years, but argues that this growth has been in response to a global financial crisis of such proportions that exceptional measures were required.
“Yes, China as a result has seen its economy grow dramatically but those who worry about the pace of expansion seem to forget, in our view, that it has been accompanied and supported by very healthy foreign currency reserves and levels of domestic savings. We believe the overall debt position of the country is, as a result, more than manageable for now.
“China’s critics would have a point if nothing were to change over the next few years and the administration left in place the stimulus package it implemented at the height of the global financial crisis in 2008/09. Yet, as we have seen, it has been quite active in paring back this stimulus in the last 18 months. True, making the necessary structural reforms will likely jar with vested interests but key is whether the government of President Xi Jinping has the stomach to drive through these reforms. Signs are good at this time, in our view, and it is critical to force these changes through in the early part of a new administration’s term of office.”
The Jupiter fund manager also plays down fears surrounding certain investment vehicles.
“As for the concern surrounding Trust products – investment vehicles used to funnel money into projects where banks are often reluctant to lend – it is unlikely to abate anytime soon given the publicity we saw late last month when a large Trust appeared close to default and was only recapitalised at the 13th hour.
“A large proportion of these trusts are due to mature, in other words the trusts will terminate and dissolve, between April and September this year. These will either be re-financed, paid off or prove to be a problem. However, given the larger-than-usual number maturing, some China critics fear it magnifies the potential risk these “problem” trusts have to destabilise the country’s financial system. “We would point out though that only a relatively small number of these Trust products are in a similar category as the above example and that the Chinese regulators are keeping a very close eye on developments here.
“Finally, we believe a lot of these concerns are already reflected in the share price of many listed Chinese financial institutions, and in a stock market that, in our view, has been talked down for much of the last 18 months. We believe progress on the required reforms will be steady but uneven and may lead to further market volatility in the coming months. Any stock market weakness could offer, in our view, a good opportunity to pick up quality companies at attractive prices. At some stage, undoubtedly, political reform will have to match the progress being made on the economy but the Chinese population is likely to be less demanding on this front as long as incomes continue to grow and it feels it is sharing in the overall prosperity brought about by the economic boom of the last five years”.