August 02, 2012

Mobius and Hasenstab of Templeton provide assessment of China and World Economic Situations

1. Mark Mobius, executive chairman of Templeton Emerging Markets Group, says not to freak out about China's economy

Yes, China’s growth is decelerating from the double-digits of recent years; various forecasters are predicting a possible GDP growth range of 7 – 8% this year. However, I think it’s important to emphasize that would still represent an impressive pace, and remember that China isn’t the world economy’s only locomotive.

Many of the world’s economies are facing slower growth trends this year, and China is also undergoing structural changes that often come with the side-effect of a few growing pains. It has been moving toward a more consumption-oriented economic model and loosening controls on the economy, which require some adjustments.

A piece of good news for China in regard to these domestic-driven efforts is that new lending during the first half of this year helped drive fixed-asset investment in China 20% higher than levels seen during the same time in 2011.

The world economy is not a single-engine affair. According to IMF projections, Africa is expected to be the fastest-growing continent on average over the next five years. And, if India is able to engage in meaningful reform, I can see the potential for growth rates there that could echo what China experienced 5-10 years ago.

Policy Tools

in recent months the Chinese government lifted limits on bank lending and on local government projects, cut loan and deposit interest rates by 25 basis points in June and cut rates again in July to 6% for one–year loans and to 3% for deposit interest rates. There have been moves to increase financing for small and medium enterprises, and, for the first time, the government has encouraged the issuance of high-yield corporate bonds on the Shanghai Stock Exchange. This is an important step since it reflected government willingness to allow more interest rate flexibility. The securities industry in China has been expanding with additional equity listings, stock options, silver futures contracts and possibly even crude oil futures in the future.

The government has also launched a round of subsidies for purchases of energy efficient automobiles and appliances, and has accelerated infrastructure projects and low-cost housing approvals.

These shifts are just some of the many tools the government has to potentially stimulate the economy, although the results might not be as immediate as other types of stimulative actions were in the past—such as massive government increases in infrastructure spending.

China also has the benefit of holding the highest amount of foreign reserves in the world (over $3 trillion) and is in control of the key banks and industrial organizations in the country. With its large foreign reserves, China has been able to learn what’s happening in Africa, Latin America, and other countries, and more importantly, buy some valuable assets that could potentially put it in good stead going forward. Recently, we learned a Chinese company struck a pending deal that could help shore up its oil and natural gas supplies via a large Canadian energy acquisition. China has been investing heavily overseas, particularly in natural resources, to help meet its growing demand

2. Dr. Michael Hasenstab, Templeton Global Bond Fund portfolio manager and co-director of Franklin Templeton Fixed Income Group’s® International Bond Department, isn’t in panic mode (about Europe or China)

Hasenstab’s assessment of current events, in his words:

“Things are difficult, but I don’t think we need to believe the Armageddon scenario. Greece appears financially terminal, but in my view, Italy and Spain by no means have to be financially terminal.”

“A country may print its way out of a liquidity crisis, but it can’t print its way out of a solvency crisis or print its way to lower unemployment rates.”

“I think there is no question China is in a mini cyclical slowdown, but nowhere near a precipitous drop.”

“Wage pressures in China have important global implications. Today, I believe China is on the cusp of exporting inflation, a completely different dynamic.”

“I don’t believe there’s a risk-free asset anymore. The question is whether you are getting rewarded for the risk you are taking. There are always opportunities, and I think if you have a long-term perspective, you can be rewarded.”

Even if China can engineer some soft landings, Hasenstab thinks China is still facing challenges tied to a necessary economic evolution, the liberalizing of assets in what Hasenstab calls “the factor markets:” land prices, the cost to the environment, and interest rates.

“Think about a typical project that might be going on in China: a coal plant. Right now, the owner can get a 2% loan from the government, build 1950s technology which pollutes the environment massively, and get the land for free. If you liberalize, he now might have an 8% loan, have to use more modern technology, and pay for the land. That’s a very different profitability or cost structure for his company. China looks like it’s on the cusp of embarking on a more efficient allocation of capital; moving from a higher growth rate with what might be considered lower quality of growth, to a lower growth rate but with a higher quality of growth. I think it’s essential to make this transition, but during the process there are a lot of potential vulnerabilities because it’s necessary for the government to kind of take its hands off the controls.”

China is also facing a potential labor shortage, which may seem hard to believe. We often think of China as having an infinite supply of labor, but its one-child policy is working its way through the population. The result? Rising wages.

“You can see this in the most basic of labor prices – migrant labor costs. They had been stagnant despite inflation, despite rising growth, and have begun heading up. Wage pressure in China will likely have important global implications. On the positive side, it will probably help rebalance the Chinese economy. One of China’s main challenges is investment outweighing consumption. How do you get more consumption? One way is to create social safety nets like unemployment insurance, healthcare or education so there is little need for a 40 – 50% savings rate. But that takes time to build out, decades. The other, quicker way is to increase wages so people will spend more. Consumers in China are no different than consumers anywhere. You earn more, you buy more stuff.”

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