China Review

ChinaIn mid September 2014 Quest visited a number of Chinese businesses, banks and the bank regulator to assess economic conditions in China. Here is a summary of what we learnt.

The Chinese economy is undergoing significant reform. The new leadership has increased the pace of reform to shift the economy away from the present fixed asset investment and SOE dependency. Whilst economic reform is significant, other policy reforms such as foreign policy action and another push against corruption are placing strains on the bureaucracy. In addition, the recent demonstrations in Hong Kong highlight the new leadership’s potential to revert to a policy of control despite the significant emergence of a Chinese middle class seeking more independence.

Regarding economic reforms, the government is attempting to balance the reform agenda on the one hand and not see significant slowdown from current lower levels of economic growth. Our impression is the risks continue to be to the downside.

Finance in China is hard to find. The banks have quota limits that are restricting advances and so small finance companies are booming, lending at rates of 20-30%! Whilst Australia has few peer to peer lenders, China has more than 1,200. We met with two of the rapidly emerging lenders and saw few signs of credit control. The Bank Regulator is currently undertaking stress testing of the banks. They were more worried about confidence than property loan default. Manufacturing appears currently to be the biggest issue in non-performing loans. The high cost of short term finance is placing strain on businesses and investors across the spectrum.

Property prices may have seen their worst, with recent government policy initiates to support some of the worst areas. No one we met expects a strong price recovery but ongoing urbanisation will consume excess supply.

The present policy to restructure the economy whilst also ensuring the Chinese economy does not weaken significantly is likely to be in place for a few years and confirms our view that our resource positions must be focused in the lowest cost producers ie BHP and Rio. These stocks are not necessarily long term holds. The current environment is also not conducive to investment in small resource companies at this time.