Focus on China: the Renminbi, Commodities and Real Estate
July 2, 2010

Developments over the last few weeks have once again brought China into focus. China recently announced that it would increase the flexibility of its currency, the renminbi (RMB). I recently said that an impending renminbi appreciation should not have a dramatic impact on Chinese stock markets since the exchange rate change was likely to be gradual. Indeed, from our observations since the announcement, the currency’s rise is likely to be gentle and controlled as the Chinese authorities carefully monitor its movement.

Since we expect the exchange rate change to be gradual, this move does not dramatically change our overall outlook on Chinese stocks, which we think should perform well in the medium term. We are still able to selectively find some attractive stocks on an individual basis, with companies related to the commodities and the consumer products and services sectors seeming to offer more interesting opportunities.

It is important to remember that the Chinese government holds over US$800 billion in U.S. Treasuries, which, in a way, limits the flexibility of the renminbi. A sharp movement in its value in either direction could potentially hurt either party, foreign or Chinese. Domestically, I think the Chinese authorities realize that, over the longer term, a stronger currency may be beneficial because of the country’s increasing raw material and commodity imports. The People’s Bank of China also recognizes that it could use the exchange rate as a tool to control inflation, which has been rising in recent months, instead of increasing interest rates.

China is a net importer of commodities, even though some Chinese companies are major producers. Higher prices may have a downward impetus on commodity companies in China but are not likely to dampen growth, since they are able to pay these higher prices as the demand for commodities continues to increase. The greater risk is price volatility, since it plays havoc with companies’ efforts to schedule production. We must recognize that prices are likely to remain volatile in the short term as long as uncertainty in the markets continues. But in the long term, I believe the demand for commodities will be strong because of rising disposable incomes in places like China, Indonesia, India and other developing countries, which could underpin a rise in prices.

One area that has already seen a sharp rise in prices is China’s real estate market, leading to concerns about a bubble forming. A bubble implies that prices rise to unsustainable levels and then crash, which we do not think will be the case in China as a whole. The country is huge and the property market is quite varied, so we can’t make a simple analysis. A few facts may clarify why I think the situation in China now is quite different from what led to the subprime crisis in the U.S. a short while ago.

  1. In China, home buyers must first put down approximately 20-30% of the total value in cash as a down payment before they can get a mortgage.
  2. The ratio of consumer lending to GDP is about 17% in China compared to 94% in the U.S. and 56% in Hong Kong.[1]
  3. Household leverage is also substantially lower in China, at about 26%, versus 124% in the U.S.1

Differentiation is important within China’s real estate market. Sharp price increases have been concentrated in the major coastal cities of Shanghai, Beijing, Shenzhen and Guangzhou. But those cities represent only about 8% of the national urban population and 8% of total residential property sales by floor space.1 More than 150 other cities have a population of one million or more. From January 2005 to January 2010, prices in the major cities rose sharply—for example, by nearly 300% in Shenzhen and approximately 132% in Shanghai.[2] But in other cities such as Chengdu, Chongqing and Xi’an, prices have not moved very much. In the case of Chengdu, the city that has seen the biggest price rise among the “smaller” cities, average home prices went from about RMB 3,000 to RMB 5,800 per square meter from January 2005 to January 2010, while in Xi’an, average prices rose from RMB 2,000 to RMB 4,500 per square meter over the same period.2

Another important point to note is that the rise in overall property prices in China has more or less tracked the rise in household income. While the real estate market may have taken on bubble-like characteristics in some specific areas, the government has been quick to react, to control and prevent bubbles, such as introducing measures to restrict bank lending on second and third home purchases. But overall, I don’t think the Chinese real estate market is in dangerous territory in terms of a bubble.


[1] Source: CEIC 12/2009

[2] Source: SouFun

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