Policy risk is among the highest risks for any investment in China, as China is famous for unexpected and sudden change in its policy. In order to minimize our exposure it is important for investors to understand Chinese culture and apply it in our market trend analysis. If we only look at hard facts and numbers, chances are we will miss out the most important part of the true message.
There have been a lot of well written articles recently about ‘Chinese market bubbles’, however I’ve not seen too much coverage about this very fundamental but important factor.
There is nothing more important than ‘Face’ in our Chinese culture. ‘Face’ (面子in Chinese) has the meaning of pride and dignity.
Here I’m not only talking about the ‘Face’ of the Chinese leaders (which is itself important), but also to the ‘Face’ of the country which will affect the sustainability of the Chinese economic growth.
‘Face’ is especially important for China from now to 2010. Beijing Olympics will be held in 2008, and the Shanghai Expo will be in 2010. Nothing is more important than to show case these two global events to the world, in order to update the global visitors about what is China; why is China a good business partner; why is it a win-win to do business with China; what sort of infrastructure is in place to support businesses, what is the quality of Chinese people nowadays; and so on. If China failed in this once a life time opportunity, the leaders and the country as a whole will lose 'face'.
I want to show you some examples of what our country is doing, down to very detailed behavior, to support my rationale:
The Chinese government has recently provided training to the customs officers and asked them to be friendlier to visitors with smile on their faces. If you have visited China previously, you probably noticed that those officers were very cold. The government has also taken actions to standardize the proper English translation of restaurant menus. (Previously those translations were so bad that you have any clue what they really mean. Look at "stewed bean crud”; "badly cooked starch cubes” or “fish in first position")
Why is the Government doing all of this? To prepare our country for the grand reception of huge number of global visitors coming to China and provide them good experience so that China can have 'Face'.
How does ‘Face’ factor relate to the debatable bubble? My view is that the Government will definitely try to manage the over-heated market by different means, such as open statements from senior government officials about their view of the market; leveraging high profile expert’s opinion [See Jim Rogers’ opinion here], and introduction of new policy. [China has banned the usage of re-finance mortgages to invest in the stock market.]
While high volatility is expected, it is important to understand that China's objective is to manage the heat of the market in a controllable manner before a real bubble is formed. Market correction is not the same as bursting of bubble, I will not believe the leaders would have any intention to collapse the market. Just think about if the market is collapsed; do you think the immigration officers can still wear smiling faces to welcome visitors? How can the leaders show the world the result of the stock market reform (conversion of stated owned shares to free floated A shares in stated owned enterprises) and the promised healthier market? If a healthy equity market cannot be shown to international investors, how can a debt market be created which in turn will directly affect the risk managment capabilities of listed banks and manage the non-performing loan problems? The country will loss 'face' if any of the above failed.
If you are a short term (in terms of weeks) speculator, this may not be a good moment for you to play the Chinese game. If you are looking longer horizon of 2-5 years, I still believe China can beat the other emerging market returns by a high degree on a risk adjusted basis.
This week the authority has approved another 5 local equity funds with total value of RMB30B after putting a stop for 2 months. This may be a sign from our leaders that "Party is allowed but do behave yourself".
I still have a long position in CAF, and I will maintain my position at least until the Olympics party is over.
Disclosure: Author is long CAF.