'Small relaxation' will send positive signal to markets

Khiem Do, one of Asia's leading investment managers, considers a key risk for the Chinese economy in 2012 is the government operating a too-tight monetary policy.

The People's Bank of China (PBOC) raised interest rates three times last year, the last 25 basis points rise being in July, taking the one-year lending rate to 6.56 percent.

But it reduced the reserve requirement ratio (RRR) in December, releasing more credit into the banking system.

"I think the main risk (for the economy in 2012) is if the government continues to operate a too tight monetary policy," he says.

The Vietnamese chair of the multi-asset team of Baring Asset Management, who was speaking from the bank's offices in Hong Kong, says the credit tightening was a factor behind the slump over the last year in China's financial markets.

The Shanghai Composite Index fell 21.68 percent last year, one of the worst years since the exchange was founded in 1990.

And he believes if there is some small relaxation this year, it will send a positive signal to the markets.

"I am not sure whether the Shanghai Composite Index will make up all of the losses of last year but it will definitely be up. It is very unlikely it will be down. There is a very close correlation between money supply growth in China and the A-share index," he says.

Do believes the government's credit-tightening measures have largely brought inflation under control and that it will fall from the December level of 4.1 percent to less than 3 percent this year.

"I think inflation will continue to decelerate after the Chinese New Year season. This month because of the celebration prices will be a bit higher but after that headline inflation will fall below 3 percent or so," he says.

Do, who has been with Barings since 1996, expects China's GDP growth to be somewhere between 7.5 and 8.5 percent this year, depending on external factors such as the euro crisis.

He believes that Europe's leading economies, Germany and France, are now preparing for a Plan B scenario of Greece exiting the euro.

"They are factoring in the exit of Greece but only Greece. They are not contemplating Italy or Spain leaving the euro. I don't, however, think Greece will be leaving the EMU (European Monetary Union) in 2012," he says.

Do says eurozone countries defaulting would not impact much on trade for either China or the rest of Asia but would hit the region financially. "You don't see a lot of Greeks holding up Taiwanese Androids and iPad look-alikes. They are quite happy using the old telephone, you know," he says, laughing.

"The problem would come if European banks withdrew all their credit lines and shut down all the loans to Asian corporates and other Asian borrowing entities here. That would be more significant than the exports of goods and services from Asia to Europe."

Do, who is an economics graduate from Macquarie Universty in Sydney, spent a large part of his career in Australia.

He worked for a number of companies including Equitilink Australia and Bankers Trust Australia. Prior to joining Barings, he was chief investment officer for Citicorp Global Asset Management.

At Baring Asset Management, apart from his Asia brief, he is a member of the strategic policy group, the company's global macro research and asset allocation team.

Apart from traveling extensively across the Asian region, he is much in demand on various business television channels giving his views on the state of the regional and global economy.

He says that after the opening weeks of the year he is relatively optimistic about the global economic situation, despite the many doom-laden predictions coming from other sources.

"I think in the middle of 2011 there were three risks, a double-dip in the United States, a European crisis and a China hard landing," he says.

"As far as the US is concerned, the data that has come out in the last six months has, if anything, surprised on the upside. In Europe, investors have been worried about a possible break up of the euro and while it is a risk, I don't think it is immediate. And with China I think what we will see in terms of growth will be closer to the long term equilibrium rate."

Do believes the PBOC has been quite decisive in its measures to tackle inflation, recognizing that headline inflation - what people are experiencing in their shopping basket - was a more important gauge than core inflation, which other central banks around the world have attempted to control.

"Even at its peak core inflation in China was only around 2.5 percent and if the PBOC were the Federal Reserve Bank, they wouldn't have been worried by that, but instead they acted. If they hadn't, I think the peak headline rate would have gone higher than 6.5 percent," he says.

Many of the government's credit-tightening measures have been directed toward cooling the property market, which has only just shown signs of easing off.

Do expects prices will fall by 10 percent this year but he does not expect the housing market to crash.

"There are only really two factors that would cause a fall of more than 20 percent. Developers with too much inventory on their hands having to offer very low prices to get rid of it and also investors needing to de-leverage and dump their stocks," he says.

"There has been some evidence of the first category in the third-tier cities. In the first-tier cities, however, there is nothing to suggest that anybody has been forced into a situation where they are having to dump their properties."

The yuan rose by 4.86 percent against the dollar in 2011 to a record high but Do does not expect any moves in 2012 to full convertibility.

There remain strict limits in China on the amount of Chinese currency anyone can convert into foreign currency.

"I don't think there will be anything dramatic this year. I think it will be steady as she goes. I don't think it is useful to predict (when the currency will become convertible). Only China knows when it will be ready. It could be five years, 10 years. I don't know," he says.

He does expect the yuan to continue its rise against the dollar in 2012 but at a steadier pace.

"I think if the dollar is strong, it is likely to be 2 to 3 percent higher this year rather than 4 to 5 percent," he says.

Do remains relatively optimistic about the so-far nascent US recovery witnessed in 2011. "I think you have to watch the animal spirits and they appear to be reviving. I am not saying they are partying yet but they are definitely recovering. I think the US will stay around a 1.5 to 2.5 percent growth rate this year," he says.

The investment manager believes that if the Republicans win the US presidential election, there could be a boost to the private sector.

"I would say the private sector would show a little bit more strength. That party always tends to be a bit more friendly toward business. And if Mr (Mitt) Romney is going to win the election, he would love to see China investing more in the US," he says.

Back in China, Do is not concerned by higher domestic labor rates forcing companies to move to other countries in Southeast Asia with cheaper wage rates.

"China is actually in control of the process. It is like a global multinational investor. It is like what the Germans have done in eastern Europe and what the Americans and the British have done elsewhere in terms of outsourcing manufacturing," he says.

Do expects the balance of economic power to continue shifting in the direction of Asia and hopes that one day it will make his life more convenient.

"As a fund manager, I am totally fed up of having to watch the opening of New York every day. I look forward to the day when they will have to wait up to watch the opening of the Hang Seng Index."

(China Daily 01/20/2012 page6)