Emerging markets rode out a short-lived sell-off in the Chinese stock markets this week, but investors have warned that the lack of visibility on the world’s fourth-largest economy is a more serious risk than anything likely to come out of the US.
Speaking at the Euromoney fixed income forum in London, Mark Dow, portfolio manager at hedge fund Pharo Management, cast doubt on how far China was vulnerable to events in the US.
“China’s exports-to-GDP ratio seems high for such a large economy. But we believe GDP is grossly understated, so the ratio is lower than it looks. Secondly, the domestic value-added in the export production chain is limited,” Dow argued.
Kevin Colglazier, chief investment officer at Standard Asset Management, observed that the macroeconomic picture, rather than the bubble in the China “A” shares market, was his main concern, as the stock market was not such a significant source of funding for the local economy.
“Economic growth is more important, especially given the Chinese demand for imports from other emerging markets. But it is very difficult to analyze what is actually going on from a macroeconomic viewpoint,” Colglazier said.
Brett Diment, head of emerging markets at Aberdeen Asset Management, agreed that Chinese macroeconomic data remains highly unreliable, and added that this compounds the opaque nature of monetary policy centred around the gradual revaluation of the yuan – most recently on 21 May 2007.
“At the moment, real interest rates remain low, and this is generating high economic growth in China and across emerging markets. It is only if we see something that meaningfully stops reserve build that we will know the exchange rate is no longer undervalued,” Diment said.
The undervalued exchange rate was also a focus for Kasper Bartholdy, head of emerging market fixed income strategy at Credit Suisse. He observed that inflation was still relatively contained, but any change in this situation would pose a potential threat.
“Economic theory says you cannot control the real effective exchange rate: either you control the nominal exchange rate, or you control inflation. Yet so far, excluding volatile food prices, we think Chinese inflation is only about 1%. If this surged, then the authorities would have to reconsider their policy on the exchange rate,” said Bartholdy.
Even without a spike in inflation, government policy could change China’s growth dynamics. Oliver Stoenner-Venkatarama, emerging markets strategist at Commerzbank’s fund management arm Cominvest in Frankfurt, believes that the Communist Party Congress in October 2007 could see President Hu Jintao advocate policies designed to soften growing wealth disparities between the eastern coastal cities and the rest of China.
“For the past 25 years, strong economic growth has been the priority policy goal. Three reform-oriented politicians appear to be in a favourable position to enter the politburo in October and to promote the balanced policy approach of president Hu Jintao. A more effective implementation of this strategy should pave the way for a stronger appreciation of the currency,” Stoenner-Venkatarama noted.
A stronger currency would also oblige Chinese exporters to move up the value chain to remain competitive, potentially putting pressure on other export-oriented emerging market economies.