Joining the China Bubble Debate, results etc.

Over the last few weeks the news flow on how some prominent global commentators believe that the Chinese economy is a bubble and that it is likely to burst sooner than later has been gaining ground. The key for us to see is that whether it is based on proper analysis or is it wishful thinking.

Given the lack of transparency that surrounds various things in China, which includes data releases, the quality of the data, actual growth numbers etc and also the fact that despite being a large economy today and constituting nearly 7% of the global economy with its USD 4.3 trillion dollar economy it still remains a very closed economy. I believe the pros and cons of China are as follows –

A high savings rate – China has a very high savings rate which at around 50% is one of the highest in the world. A high savings rate can sustain high growth even in a scenario where there is a lack of forex inflows.

Large current account surpluses – The large surplus on the current accounts as well as the trade account even in times of a sharp slowdown in global growth reflects that China still continues to be competitive in its production across a wide swathe of industries.

Low Debt to GDP – I believe that this is the biggest positive of the Chinese economy where the government debt to GDP is at very low levels. This is mainly due to the fact that despite the strong boom in China over the last twenty years the government finances have been under control and China has largely been running budget surpluses. As such despite a huge fiscal boost it does not create stress on future potential stimuli.

China still remains competitive vis a vis all others in a vast majority of industries – Despite wage cost inflation picking up sharply in China over the last few years it continues to be competitive versus the competition in a large number of industries. Moreover the balance sheets of the large number of such companies are not very highly leveraged and overall debt to equity remains well under control.

The Chinese government has huge capital assets – Given the high ownership of the Government in a vast majority of Chinese companies across industries the government has huge capital assets whose value would be much larger that the amounts invested by the government.

Besides this other positives are that it is a large country with large areas still requiring development and also the fact that the strategic thinking of China in acquiring natural resources all over the world is also important to consider.

However despite all of this I believe that there are negatives which include

A highly controlled economy – As the Chinese economy has become very large the kind of state control that China has continued to maintain where the government decides when there should be consumption and when there should be investment or what should be consumed and where investments should be made is going to create more and more difficulties going forward.

The hugely overvalued Yuan – This is the biggest negative in China where the strategy of keeping the currency undervalued is creating a false sense of complacency among companies in that country. As against most emerging market currencies which have appreciated between 20-35% vis a vis the USD the strongest growing economies currency remains pegged. What this essentially also means is that it has actually lost value against the Euro when the Euro zone is going through its worst recession. This I believe is completely unsustainable. The Japanese could not keep their currency weak when they wanted and similarly there have to be sharp adjustments in China also. As and when these adjustments happen it will create scenarios where other countries will become more competitive in lot of industries.

Huge Subsidies for exports – In order to sustain its exports china continues to give huge subsidies across industries. These are also unsustainable in the long run.

Huge credit growth for a 9% GDP growth – New loans in China at USD 1.3 trillion last year is nearly 30% of the Chinese GDP. As against this India is growing at 7.5% with a Credit growth to GDP ratio of just around 6%. This shows to me that there is something wrong in the Chinese economy. I believe this is a very important thing which most people are missing out on. It also shows a lack of efficiency of capital usage.

An ageing population at per capital GDP of USD 4000 – The Chinese population is expected to start ageing sooner that most countries at this stage of development due to its one child policy. This would be one of the fastest aging as most economies have reached this stage at per capital GDP’s more near USD 15-20000.

Although I am sure what I have written about are limited points and there might be many other important ones that I might have missed, there are arguments both for and against there being a Chinese market bubble. I would argue that no bubble burst seems to be imminent at this point of time; however the unbridled expansion of credit combined with currency controls has the potential of leading China into a very tight corner over a period of the next 3-5 years. As such we should still see a good run in Chinese assets for some time to come.

Coming back to India now

Results season begins

Results season has begun well with Infosys delivering above expectation results. Most results out till now have been pretty strong and as such should lead to earning upgrades. Auto and cement sale numbers for December have been very positive and should reflect in company earnings.

The industrial production data has also been very positive and should continue to improve going forward. The moves by the government on disinvestment are also been taken positively by the markets with there being a strong run up in most PSU stocks.

The award of road and highway projects has picked up sharply; this was one of the key monitorables which lot of investors were looking at. This is very positive for the entire gamut of infrastructure related companies right from construction, equipment suppliers, cement companies etc. This will also be very positive for employment generation given the huge labour intensity of these projects.

Overall things continue to remain constructive for the markets going forward.

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