Asset Allocator’s Soapbox: Jason Hepner

Jason Hepner, investment director for Global Strategy at Standard Life Investments, on tightening tensions in China.

Chinese policymakers have recently embarked on robust initiatives to tighten monetary policy. The most recent measures are targeted at the overheated property market, and include a complete ban on purchases of second homes across a range of large and mid-sized cities, accompanied by a message of strict enforcement of the rules to deter property market speculation.

This has prompted the market to become concerned about the risks of policy tightening too far, too fast. There are fears that the Chinese may derail economic growth, just as the global economy loses momentum. Indeed, this is what happened in late 2007 and early 2008.

When considering why monetary tightening is necessary, it is important to examine inflation in China, in particular consumer prices. The most recent CPI reading was 4.6% for December. This was mainly driven by food prices which rose almost 10% from a year earlier. Although such food price inflation was slightly lower than the previous month, it is sufficiently high to be causing consternation among policymakers.

Furthermore, what is really quite concerning is that ‘non-food’ prices continued to edge higher, to 2.1% year over year. The government has accepted reality, raising its inflation target to 4% for this year, cognisant that 3% is too low a level for a fast growing emerging market at this time.

In terms of property prices, the authorities have managed to slow the recent rate of appreciation, to 6.4% a year at the most recent reading, from 12.8% at its peak back in April. That said, however, there are still pockets of excess in certain cities, and property prices appreciating too fast are socially very unpopular.

Furthermore, if property prices grow too quickly for a sustained period, it can lead eventually to ‘boom and bust’, as we have seen most recently in some key developed market economies. The most recent measures announced included a complete ban on purchases of second homes in 40 of the largest cities, a sharp increase in the deposit required for purchases of any second homes, and targets given to local governments in terms of what amount of property price appreciation was desirable.

Monetary tightening has come in many forms. We have seen four increases in bank reserve requirements in as many months, most recently in January. We have had several interest rate hikes, most recently on Christmas Day. Major banks are being held to account for the amount and quality of their lending. It is little wonder that with such multi-faceted monetary tightening, the financial markets are nervous, given China’s importance as the world’s second largest economy.

That said, some of the market’s concerns appear a little overdone. It is important to bear in mind that in 2010, a year when the market suffered large bouts of nervousness regarding monetary tightening, new Renminbi lending amounted to close to RMB 8trn (around US$1.2trn). This is a very large sum in an economy that is close to US$ 5trn in terms of size of its GDP. The indications for new lending in 2011, are that it will be somewhere in the region of RMB 7trn, hence another year of ample liquidity.

Growth

The Chinese economy, amid all the noise, is demonstrating a large amount of growth momentum as we progress into 2011. In 2010, the economy managed a very respectable growth rate of over 10% in terms of real GDP. In 2011, all the indications are that the economy will again grow by close to 9%, still an impressive result.

Retail sales, industrial production, and fixed asset investment growth are some of the indicators we look at, all of which corroborate the view that the Chinese economy is showing a great deal of macro resilience. It is clear that Chinese policymakers have to come to terms with the inflationary consequences of fast growth. What seems clear, however, is that the Chinese government remains resolute in its pursuit of reliably fast growth.

The markets are banking on better weather in the spring. As and when commodity prices finally roll over, and inflation fears ease, financial markets will heave a collective sigh of relief.