Hello DJ, I received the following in the e-mail from a friend:
Hi Jay,
Though you may not be spending as much time lately in China, what are your thoughts/views in regards to the questions posed on China's growth outlook today, which are argued/discussed in the piece below from Joe Zhang?
Best, XYZ
----- Original Message -----
From: joe.zhang @ UBS
Sent: Friday, September 19, 2003 9:39 PM
Subject: Basic materials vs. China tightening
Summary:
Credit tightening will slow the economy modestly, but do not expect a collapse;
Yanzhou Coal, Chalco and Baosteel are among the most solid companies;
Stock price corrections will present buying opportunities.
Details:
* Bubbles, or the fear of bubbles? First, there was the increase in bank reserve ratio. Then, we heard warnings about bubbles in this or that sector. Is China in for a hard landing? We believe the choice for policy makers is: high growth, or very high growth.
* The government's competing needs. One week after the central bank lifted reserve ratio, the prime minister chaired a summit on a "Fast-Forward Plan" for China's rust-belt (three northeast provinces). This is in addition to the "Go-West" strategy, which is leading to very substantial infrastructure building in central China.
* Mega-trends: migration, and jobs. The need for high economic growth is made clear by political leaders in their recent speeches. China must create about 20m jobs a year to absorb new entrants to the labour market, let alone to deploy downsized SOE workers,
and migration from the countryside.
* Olympics, Treasury bonds, and NPLs. Infrastructure building for the 2008 Olympics, and the 2010 World Expo has just started. The government has vowed to use these events to stage a major urban renewal. In our view, the cancellation of the T-bond issues this week due to a rising bond yield is a warning to policy "hawks". So is the threat
of higher bank NPLs.
Inflation, wage growth, or rising asset prices? If there were many “bubbles” in the economy, why did they not show through inflation rates, and rising interest rates, wages, or asset prices (or stock indices)? At present, China does not have inflation, and interest rates are stable (except the bond yield hike caused by the lifting of bank reserve
ratio).
Moreover, the A-share stock market is going south, and few other assets command any pricing power. Finally, factory wages are falling, instead of rising. In the past three years, only civil servants and government workers have received wage growth.
Does China have economy-wide “bubbles”? Our economist, Jonathan Anderson, says no. He argues that it is too early to talk about a hard landing (although property developers, autos, steel, semis could go through some rough times ahead). Most merging (or even developed) crises come about because policymakers let things run for years. In China, where memories of the last boom/bust (1994-95) are still very vivid, we have been worried about overheating for twelve months and the authorities have been sucking out liquidity from banks for nearly that long (Note the base money decline).
Bubbles are often made by complacent authorities, but the Chinese government has not been complacent in the past year. In fact, it has done much to try to dampen growth in autos, steel, aluminium, cement, glass, and everything else.
Unlike Hong Kong’s government, there is no official intervention in China’s property market. So, Beijing’s property prices have fallen in the past year, and overheating remains isolated incidents, in our view.
Short-term vs. long-term issues.
Let us be cautious about the near-term outlook for China. Suppose the growth rates for industrial production will be halved from, say, the current 20%+ to only 10% in 2004. This would still be a very high growth rate. Even under this scenario, Chinese demand for basic materials from the rest of the world would still be strong.
Most importantly, if industrial production growth is halved, it would not only cut demand, it would reduce supplies as well. This should remove some fear among foreign companies about China’s growing exports of aluminium, steel, and other basic materials.
Constraints on the Chinese government are very real, and can potentially reverse the government’s credit tightening any time. These constraints include the need to create jobs, urbanization, the grand strategy to revitalize the “rust-belt” provinces, the infrastructure building for the Olympics/World Expo, and the “Go-West” strategy. In our recent note (1 September), “Reactions to China’s credit tightening”, we found that there is enough debate in the government about the credit tightening.
Currently, only 36% of Chinese live in cities (compared to 19% in 1979). With the recent gradual lifting of restrictions long imposed on rural residents, we expect the urbanization ratio to continue to rise. A 1-ppt increase in the ratio should translate into 13m additional urban residents, posing pressure on urban infrastructure, housing, power demand and
telecommunications. Urbanisation means additional demand for jobs, calling for higher economic growth and more accommodating macro policies. On the other hand, it puts downward pressure on wages, and neutralizes some inflationary pressure (if there is any).
Intensifying shortage of oil, gas, power, iron ore, and even coal.
On 16 July, we published a 48-page report on China’s shortage of oil, gas, power, iron ore, and even coal, entitled “China’s Energy Policy Dilemma”. We stand by its conclusions. We believe that these are long-term challenges for China, and the current shortage will only intensify in the coming years. If a modest slow down in the Chinese economy leads to the growth rates of imported basic materials to weaken from, say, 30% to 15%, it should still be high enough growth.
Nothing illustrates China’s energy shortage better than the current electricity rationing. Short-term factors aside, let us highlight one finding in our report: the impact of urbanization in the past two decades has had on power demand (see chart below).
Our chart shows, in the 13 years, China's total electricity consumption rose 7.5% CAGR (a high rate), but households’ electricity consumption rose 13.2% CAGR. In absolute terms, this represents a fivefold increase in 13 years. We believe that implications of continued urbanization will be the same for copper, aluminium, nickel and others.
Stocks: Yanzhou, Chalco, Baosteel.
We recently downgraded our ratings on Yanzhou Coal and Aluminium Corp of China to Neutral 1 and Neutral 2, respectively, after they reached our target prices. From a macro point of view, we believe it is likely that news flows will China's tightening vs. basic materials 19 September 2003 be negative on these companies in the next few months. But we believe they are among the most solid Chinese companies, and if the shares were to fall, they could potentially offer good value.
We believe the country’s power and coal shortage will continue and will probably worsen by 2005-06 when about half of large coalmines approach their retirement. The global alumina market remains quite tight as there are few new projects coming on stream in the next two years. The rising demand for aluminium by the power sector, autos, property and packaging should continue to support alumina and aluminium prices. We expect to keep our product price forecasts unchanged despite the recent changes in China’s macro policies.
On Baosteel, we have retained our Buy 2 rating, and think the recent concerns in the market are overplayed and that its mid-term outlook remains solid. Its three recent acquisitions from its parent should add impetus to growth and broaden its product offerings. We think the credit tightening will likely hurt its competitors more than hurting demand for its products.
|
