China in 2011: 7 Important Themes

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by: DayOnBay

By Simon Cai

China made plenty of headlines in 2010. Here is a reflection on several of the most discussed topics related to China in the past year, along with predictions on how they are likely to impact economic growth and development in the year ahead:

1. GDP Growth

The rate of GDP growth was strong in China in 2010 with an estimated 10% year-on-year growth. Growth was buoyed by a relatively high level of credit quota (the amount of new loans that banks can issue) at 7.5 trillion RMB along with a number of government stimulus programs. With concerns surrounding the sustainability of the global economic recovery, including the sovereign debt crisis in Europe, the lending quota for 2011 will likely remain near the same level as last year. As well, investment and consumption should continue to increase at a steady rate. According to estimates from Bank of America Merrill Lynch and Goldman Sachs, GDP growth will likely remain in the 9% to 10% range even as the government cautiously implements measures to cool off the overheating economy in 2011.

2. Inflation

In the last quarter of 2010, high inflation in China resulted in headlines all over the world due to its potential to cause social unrest (e.g., high inflation was one of the factors behind the Tiananmen square protests of 1989) among the working class Chinese population, and the tight monetary policy that could follow which would have a negative impact on global economic growth. In November the CPI increased by 5.1% on a year-to-year basis, with food and residence expenses accounting for 92% of the price increases. In 2011, the Chinese government will continue to intervene to keep inflation at a reasonable level of 4% to 4.5%. From rising interest rates to more restrictions in the housing sector, a range of policies will be implemented as needed to contain inflation due to its political importance.

3. Credit Growth

The government has tried to control the growth of credit in China mainly through regulating the following three channels: credit quota, reserve requirements and benchmark interest rates. Out of those three, the one with the most impact on credit availability is credit quota since it strictly limits the amount of loans banks can issue. The quota for 2010 was set at 7.5 trillion RMB, but this limit will likely be breached since well over 95% of that amount was already issued by the end of November. With one eye on maintaining strong GDP growth and another on controlling inflation, it is expected government officials will likely keep the credit quota somewhere near the 2010 target.

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4. Currency

Controversy over the RMB’s under-valuation was most prominent during the run-up to the G-20 meeting in Toronto last year when Chinese authorities gave in to international pressure and decided to let the currency float. Since then, the appreciation has been limited. More international pressure will likely manifest this year from not only the U.S., but also other countries such Brazil, in order to maintain the competitiveness of their exports. The Chinese government will likely let its currency rise by 3 to 5 percent, partly to ease inflationary pressure as a higher currency will make the country’s imports cheaper.

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5. Domestic Consumption

Household consumption makes up a small percentage of the country’s GDP, with most estimates between 35 to 40%. In contrast, consumption contributes to 65% of the GDP in the United States. In an attempt to wean the Chinese economy off its dependency on exports, the Chinese government’s new five-year plan will likely include measures that will encourage consumers to save less and spend more with the goal of having consumption drive economic growth instead of exports. This will likely be accomplished through a redistribution of income from the state to the working class and the implementation of a wider social safety net.

6. Offshore RMB Market in Hong Kong

As part of the push to establish the RMB as a trade settlement currency to reduce currency transactions costs and currency fluctuation risks faced by the nation’s exporters and importers, China started to ease its capital controls in 2009 to allow for the development of an offshore RMB market in Hong Kong. In 2010, the offshore market grew exponentially with retail deposits totalling 280 billion RMB by the end of November, which represents an increase of 246% from a year ago. Some developments in this market include new financial instruments being offered by banks to investors such as forwards, swaps, and other derivative instruments. Companies can also now raise RMB funds in HK through RMB denominated bonds, also known as Dim Sum bonds. In 2011, it is likely that more RMB denominated securities are issued to satisfy the strong demand from investors eager to put their RMB deposits to work.

7. Hunt for Energy

With rapid economic expansion in place, the demand for energy and other natural resources has been increasing exponentially for a number of years now. Notable deals in 2010 include Sinopec’s acquisition of a 40% stake in Repsol Brazil for $7.1 billion for Brazilian offshore oil reserves and CNOOC’s $1.08 billion investment for a 33% stake in Chesapeake Energy’s Eagle Ford shale project in Texas. With steady growth on the horizon, this trend will continue for the foreseeable future. This translates into more Chinese state-owned companies looking outside of China to buy assets or acquire stakes in natural resource companies. Taking into account the political hurdle that Chinese state-owned firms must overcome in North America and Europe, the most likely targets for acquisition will be located in South America, Africa and Southeast Asia. Coming off a year of double digit returns for most commodities, 2011 will be another strong year for commodities helped with growing demand from China and other emerging countries.

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Coming off years of double-digit growth, this year should mark the beginning of a period where we will start to see a lower yet more sustainable rate of growth in China as the country continues its transition to a more domestically driven economy. From acquisitions to satisfy China’s voracious energy needs to sensitive issues including inflation and currency, China is guaranteed to garner its fair share of headlines this year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.