||As this year comes to a close, many are
looking to 2013 with the hope that the
global economy will pick up at a faster
pace. All eyes are on China, which
remains an engine of global growth.
Here, Regional CIO, Asia Pacific, Yonghao Pu talks with UBS Perspectives to answer the questions that matter: How does China’s ongoing recovery compare with its own recent turnarounds? In what direction might the country’s new leadership steer it? What is in store for Chinese equities in the medium-term?
UBS Perspectives: Despite some impressive economic numbers, many people still feel that China is not recovering fast enough. Are they right?
YP: China’s recovery will not come very easily. The government has learned its lesson from overdosing the economy in reaction to the 2008– 2009 global financial crisis. Its CNY 4 trillion spending package in 2009 planted the seeds for asset bubbles in 2011, which forced the government to cool down the economy through various austerity measures.
Compared with its recovery from the past two major downturns, in 1998 and 2002, this one is going to be a longer process for China. The government is more deliberate in addressing structural problems like industry overcapacity. It’s now aiming for a more sustainable recovery rather than a quick turnaround, which could later result in bubbles.
UBS Perspectives: Can you elaborate on the differences between the current situation and the past two recoveries?
YP: The downturn in 1998 was largely a result of the Asian financial crisis. Luckily, the US and major European countries were in good shape then. The US Federal Reserve aggressively cut interest rates at the same time that the renminbi had devalued in the black market by as much as 15%. As a result, China’s exports rebounded strongly in 1999 and even further in 2000. The government also launched a stimulus package that cushioned the internal shocks caused by the reforms to state-owned enterprises, which then boosted fixed-asset investments.
The downturn in 2002 came in the aftermath of the 9/11 attacks in the US. China’s export growth faded away and industrial production growth slowed down. However, China had joined the World Trade Organization in 2001, and this game-changer gave a huge boost to the economy through foreign direct investment and overseas sales. Export growth was exponential over the following years, and full economic recovery started in the second half of 2002.
UBS Perspectives: How is China stimulating the economy now?
YP: The government announced a CNY 1 trillion infrastructure-spending program last September, and plans to deploy the money gradually. Since this amount is only a fraction of, and will be spent over a longer period than, the previous package, I don’t believe it will lead to the same sharp economic rebound experienced in 2009. At the same time, the sources of funding are much tighter now, since both state-owned banks and the Ministry of Finance are more cautious about funding projects. We can actually more accurately call the current spending package a “stabilization program”, rather than a stimulus program.
UBS Perspectives: So why is Beijing more cautious this time around?
YP: One key reason, other than having learned its lesson from the 2009 stimulus, is that the overall job market seems to be holding up well. Many small, export-oriented companies had to close down this year. However, the workers they laid off mostly supplied the labor shortage at other companies, which is why there has been no sharp deterioration in China’s job market. Of course, if the economy does not recover, it will have a more negative impact on employment.
Another reason is the leadership transition this year. With new Communist Party politburo members having taken office in November and government ministers taking office next March, there has been a policy vacuum at the top. Though the new leaders have long been in power and involved in policymaking, it would still be in their best interest to start with a cleaner economic slate—with fewer risks of bubbles and overcapacity problems— and therefore let the existing tightening measures run their course. In short, they’re not in a hurry to produce a quick turnaround or to engineer one at the risk of seeding new bubbles.
UBS Perspectives: So what can we expect from China in the near-to medium-term?
YP: The government’s growth-stabilization program and the business sector’s inventory buildup have started to cushion the economic slowdown. Once businesses are past their inventory-reduction cycle, we expect the economy to modestly recover during this quarter. This assumes that domestic inflation does not spike and the massive easing measures taken by both Europe and the US do not create major external shocks. We expect China’s GDP growth to hit bottom at 7.5% this year and recover to 7.8% next year.
UBS Perspectives: Given that view, what is your outlook for the Chinese equity market?
YP: Based on the MSCI China index as of end-October, the market is still trading at more than 20% discount to historical average. Given attractive valuations and a bottoming economic cycle, fund flows are returning to the region. We expect further upside for Chinese equities before the end of the year, supported by seasonal factors, such as inventory restocking and infrastructure spending. It also depends on the US avoiding a fiscal cliff and the huge monetary easing in the US and Europe improving their economic momentum. For the first quarter of 2013, market valuations should remain attractive, and we see upside potential assuming the economy continues to recover.