Monday, May 24, 2004

China Aims Squeeze on Credit
At Asset Bubbles in Hot Sectors

May 24, 2004; Page A12

BEIJING -- Senior Chinese economic officials said the government's squeeze on credit won't induce a hard landing for the economy but instead is designed to shrink asset bubbles in troubled sectors.

The governor of the People's Bank of China, Zhou Xiaochuan, and other officials said there are signs that recent policy measures are having an effect on restraining runaway investment and slowing rapid growth while inflation remains under control. Speaking at a forum on China's economy Friday, Mr. Zhou used the example of Japan's decade-long malaise, induced by an asset bubble, to justify the government's decision to tighten credit.

"Usually people pay most attention to asset bubbles in the stock market and property market, but this might not be the case in China," Mr. Zhou said. "China's asset bubble may lie in the manufacturing sector and other raw-material processing sectors where we see oversupply."

The comments at the forum inside Beijing's Great Hall of the People underscore the delicate balancing act Chinese leaders are attempting: maintaining fast economic growth to generate jobs and returns for investors while keeping the momentum from spinning out of control. As a sign of their caution, the officials said an increase in interest rates -- potentially the first in nearly nine years -- is being held in reserve. "If the monetary policy produces results fairly slowly, if the situation continues to unfold, we may need to adopt more vigorous efforts with regard to macroeconomic controls," said Vice Minister of Finance Lou Jiwei.

China's central bank adopted a tighter monetary policy late in the third quarter of 2003 and then stepped up efforts this year, primarily by gradually raising the reserve requirements for banks. Bank of America analyst Sameer Goel said Mr. Lou's remarks indicate that the current credit policy will be sustained even if the vice minister suggested that the overheating hasn't been fully addressed.

"This can be interpreted as a signal that the [central bank's] relatively dovish statements of late won't necessarily be overridden," Mr. Goel said.

National Bureau of Statistics Director Li Deshui appeared to caution against blunt measures such as interest-rate increases to tackle what is primarily a few hot industries luring too much money.

"China's economy hasn't shown an overall heating, and therefore we don't need and shouldn't implement an overall tightening policy," Mr. Li told the forum. He said China's already-implemented monetary-policy measures are "appropriate and well-timed" and that as they take effect, economic growth will slowly stabilize during the second half.

China's chief statistician also was unfazed by rising inflation, telling reporters he doesn't think the rise in China's consumer prices will necessarily exceed an annual rate of 5% in May. That level has been singled out as a danger point for China's interest-rate policy, as inflation creeps closer to the prevailing one-year loan rate of 5.31% set by the central bank.

Not everyone shares the official confidence that a mix of administrative directives to local authorities to curtail investment and higher bank-reserve rates will do the trick.

Goldman Sachs Managing Director Fred Hu said China should pursue steps using more market-based, indirect macroeconomic controls.

"The People's Bank of China should raise the interest rate by [two to three percentage points] in the next 12 to 18 months," Mr. Hu told the forum. "Due to higher inflationary expectations, only by raising real interest rates can we really curb investment demand."

However, Mr. Li said inflation remains under control despite hitting 3.8% year-to-year in April, a seven-year high. "As long as macroeconomic control measures are well implemented we can prevent inflation, which is currently still within the controllable range," he said.

Investment and lending growth helped China's economy expand 9.8% year-to-year in the first quarter, nearly the same pace as a 9.9% annual growth rate in the fourth quarter of 2003.

In a quarterly report issued Friday, the Ministry of Commerce predicted China's economy will grow by more than 9% year-to-year in the first half of this year.

Mirroring the predictions of China's chief statistician, the ministry report forecasts that GDP growth in the second half will be slightly slower than in the first half of 2004.

Oil-Thirsty China
Begins to Build
Reserve Facilities

Beijing Official Says Crude
Will Be Stockpiled Slowly
To Avoid Market Disruption
May 24, 2004

AMSTERDAM -- In a step that could boost Chinese demand for oil, Beijing's industry czar said the country has started building tanks and other facilities for a strategic petroleum reserve but hasn't begun stockpiling fuel.

The comments by Zhang Guobao, vice chairman of China's National Development and Reform Commission, to reporters on Sunday represented some of China's most detailed statements on its widely watched plans for a strategic oil reserve. China had said it planned to create a stockpile but offered few details.

Oil traders have been eager to know whether such stockpiling is partly behind surging Chinese demand for oil, which has helped drive petroleum prices to their highest levels in two decades. The fact that China isn't stockpiling yet means China's economy is fueling the market demand -- and that once the reserve purchases begin, Chinese oil purchases could grow.

Mr. Zhang stressed that China will build its reserves slowly so as not to disrupt markets. He provided no indication regarding when oil purchases might begin. In the longer term, the reserve is likely to be a stabilizing influence on the world economy, by giving China's manufacturing sector a buffer in the event of sudden supply disruptions. Western policy makers have been urging Beijing to build a strategic storehouse, as the U.S., Japan and other economic powers have done.

Meanwhile, with concerns mounting that oil prices may be spiraling out of control, Saudi Arabian oil officials said over the weekend that the kingdom has increased output to 9.1 million barrels a day, a rise of an estimated of 600,000 barrels a day, or 7%, from last month. (See related article.)

Saudi Oil Minister Ali Naimi announced Friday an increase in output to nine million barrels a day effective in June. But Saudi officials said privately that the production increase has already begun. Mr. Naimi also said the Saudis will produce even more oil if customers order it, suggesting that the world's No. 1 exporter could push its output toward its current capacity limit of 10.5 million barrels a day.

In an interview with the Arabic-language newspaper al Hayat, Mr. Naimi also called on OPEC to increase its output quotas by some 10%, or as much as 2.5 million barrels a day. That marked the third time in two weeks he has raised his suggested target for the group.

But even as the Saudis make every effort to rein in prices, they and others in the Organization of Petroleum Exporting Countries suggested at an oil-world summit here over the weekend that higher oil prices are here to stay. OPEC officials are increasingly talking of targeting a higher price range for a barrel of oil.

The U.S. benchmark crude oil is trading near $40 a barrel, and OPEC's own basket of oil types is around $37 a barrel. But those figures are considerably higher than the range of $22 to $28 for the OPEC basket that the cartel has targeted for the past several years. Oil prices have been above the OPEC price band since December.

Qatari Minister of Energy and Industry Abdullah bin Hamad Al Attiyah said Sunday that a range of $28 to $30 a barrel is "a very reasonable price for consumers and producers." Nigeria's oil minister said the cartel should now target a minimum price of $28 a barrel.

China's Mr. Zhang stressed that Beijing will build up its stockpiles slowly so as not to disrupt energy markets. "Construction [of the facilities] will be done gradually and additions will be made gradually," he said.

He also noted that because China is itself a large producer of oil, the country will build smaller stockpiles than those of many developed countries. Western countries generally target 90 days of imports for their strategic stockpiles. He wouldn't specify a target, but said China's reserves will be far smaller than those of Japan, which he pegged at 150 days of imports.

Mr. Zhang said Chinese oil imports will rise about 10% for 2004 to 100 million tons from 91 million tons in 2003. He said recent government measures to restrain the Chinese economy have begun to moderate demand for raw materials such as iron ore, whose prices have begun easing in China, and should have a similar effect on energy demand.

"I think that after the macroeconomic measures that have been taken, the tightened supply of raw materials and energy will be relaxed," he said.

But Mr. Zhang said China doesn't expect overall economic growth to fall substantially in the second half from the current red-hot pace, because economic fundamentals are strong. He said China's gross domestic product in first four months of this year grew 9.8%.

Monday, May 17, 2004

China's Economy Continues to Race Ahead

ONG KONG, May 13 - China's economy continued to barrel ahead in April despite a series of measures by Beijing to slow growth, a raft of statistics showed on Thursday.

Industrial production, bank lending, foreign investment, imports and the money supply all roughly maintained in April the breathless pace they had set in March, three government agencies announced. The only appreciable slowing came in the growth rate for exports, which caused the trade deficit to widen.

Beijing has been trying to slow investment in apartment buildings, factories and other fixed assets, which rose 43 percent in the first quarter. Officials have expressed concern that the construction-led boom may kindle inflation in the short run, as buyers bid up raw material prices, and result later in a glut of goods that could cause deflation accompanied by large-scale loan defaults, hurting an already weak banking system.

The robust performance in April was partly because Chinese leaders had taken few meaningful actions before the month began. But the strong growth in April also underlines the difficulty of slowing the economy in China, where an unusual combination of capitalism and economic planning means that policy makers are limited to fairly blunt tools, said Li Kui-wai, who teaches economics at the City University of Hong Kong.

"In China, it's difficult to slow down the economy - you have to stop it," he said.

Chinese leaders began issuing fairly strong warnings in March about excessive growth, especially encouraging banks to slow their rate of new loans. But most of the policy-tightening measures have had little time to take effect, economists said, adding that the recent moves might yet put a brake on the economic expansion.

In two heavily publicized actions in late March and early April, the People's Bank of China, the country's central bank, raised reserve requirements by a full percentage point for financially weak banks and by half a percentage point for stronger banks, including the so-called Big Four national banks. But the higher requirements, which forced banks to set aside money that otherwise would be available for lending, went into force only on April 25 and are unlikely to have had much effect.

But another measure should have had some effect: a warning to banks by the China Bank Regulatory Commission on April 27, ordering them to limit their commitments to new loans for the next four days before weeklong May Day holidays began.

Despite that order, the volume of bank loans in April was up 20.4 percent from a year earlier, little changed from a year-over-year increase of 20.7 percent in March. The money supply was up 19.1 percent in April, the same as in March.

Chinese officials said early this year that they wanted domestic credit and the money supply each to increase no more than 17 percent this year. Michael Pettis, an associate professor of finance at Tsinghua University in Beijing and a former investment banker, pointed out that the Chinese have not met their goal for either indicator in any month this year even though the goals were set very high.

"Even if we were able to hit it, I would argue it is excessive growth," Mr. Pettis said.

Beijing has started taking tougher measures in the last two weeks, ordering sharp restrictions on bank lending to overheated industries like steel and cement, and even disciplining and denouncing in the national media a group of Communist Party members involved in the construction of an especially costly steel plant in Jiangsu Province.

Industrial production rose 19.1 percent in April from a year earlier, compared with 19.4 percent in March. Foreign direct investment actually accelerated, climbing 10.1 percent for the first four months of the year compared with the period last year. Foreign investment had been up only 7.5 percent for the first three months of the year; China reports foreign investment figures on a year-to-date basis.

Contracts for future foreign direct investments soared 54 percent for the first four months of this year, but that was compared with a weak pace of contract signings a year ago. An outbreak of severe acute respiratory syndrome, especially in Hong Kong, discouraged many foreigners from visiting China in late March and throughout April.

Imports jumped 43 percent in April compared with a year earlier while exports climbed 32 percent. The faster growth of imports produced a trade deficit of $2.3 billion.

While prices have slipped in recent days for many raw materials, except oil, China was paying dearly for these imports through most of April. At the same time, prices were little changed for the mostly manufactured goods that China exports.

The People's Bank of China reported on Wednesday that its index of corporate goods prices, which tries to measure price increases for everything that companies buy from one another, climbed 9.3 percent in April compared with a year earlier. The year-over-year increase had been 8.3 percent in March.

A National Statistics Bureau official said that the agency would release the April consumer price index on Friday. Inflation at the consumer level was running at an annual pace of 3 percent in March, according to official figures that have prompted some skepticism among independent economists.

Thursday, May 13, 2004

Recent Drop of Property Stocks In Hong Kong May Be Healthy


HONG KONG -- Investors' fears that interest rates are about to rise and that China's economy is headed for a fall have had one unintended benefit: they've brought Hong Kong-listed property stocks back down to earth.

During the past month, the Hang Seng property subindex, a subgroup of Hong Kong's benchmark Hang Seng Index, has fallen 18%. Wednesday, it ended at 13874, compared with about 17000 a month ago and a peak of 18353 in January. Analysts say the slide is due to investor concerns that the U.S. and China are going to start raising interest rates, and that China's economy is overheated and due for a significant slowdown.

The drop in property stocks comes after a run-up in which the Hang Seng property subindex more than doubled since April of last year. It rode a stronger-than-expected rebound in the Hong Kong real-estate market following last year's outbreak of severe acute respiratory syndrome.

Taking Hits

Shares of some of Hong Kong's biggest property developers have taken big hits since the start of the year. Henderson Land Development closed Wednesday at 31.60 Hong Kong dollars (US$4.05), down 25% from its 52-week high of HK$42.40 in January. Sun Hung Kai Properties were at HK$62.25, 22% below this year's high of HK$80, also reached during January. And Hang Lung Properties closed at HK$9.50, or 27% below its 2004 peak of HK$13.05.

But rather than fret about the decline, many analysts are welcoming it as a needed correction and one that brings property stocks down to more-sustainable valuations. The share prices of most property stocks are still well above their lows reached a year ago during the SARS outbreak. This year's cooling off of a property surge, some observers say, is creating buying opportunities.

"Property stocks look very good based on the current values," says John Saunders, head of regional property research at CLSA Ltd. in Hong Kong. "We expect the shares to rebound in the near term," he adds.

Analysts are now recommending selected stocks. Eva Lee, a research analyst at ING Financial Markets, recommends buying Henderson Land and Hysan Development. Both have good fundamentals and are "likely to outperform the market when prices rebound," she says.

Bullish on Retail Properties

Douglas Sung, head of real-estate research at J.P. Morgan Chase in Hong Kong, likes Wharf Holdings because of its ownership of retail properties. He is bullish on that sector because it is benefiting from growing numbers of Chinese tourists shopping in Hong Kong.

Many analysts say that prior to the current correction, they had been concerned that property stocks were rising to unsustainable levels, and that a bubble may have been forming in property stocks and the Hong Kong real-estate market, as speculators bought up shares and property. Hong Kong has seen real estate boom and bust before. Prior to the previous property crash in 1997, some people in Hong Kong were even buying properties in the morning and selling them in the evening.

"I think valuations were very high at the start of this year. This correction is healthy. Obviously it's painful over the short-term, but it should prove beneficial going forward," J.P. Morgan's Mr. Sung says.

The rebound in Hong Kong's real-estate market during the past six months has been dramatic. Spurred by low annual mortgage rates averaging 2.5%, a solid rebound in the city's economy and a declining unemployment rate, companies and citizens have been buying and leasing property at a fevered pace since the market bottomed last November.

According to real-estate consultants Cushman & Wakefield, the vacancy rate for prime office space in Hong Kong's premier central district has fallen to 16.8% from 26% a year earlier. Rents for office space have risen an average 34%, while the purchase price for luxury residential properties has risen 40% during the past six months, Cushman & Wakefield says.

Downward Pressure

A correction in real-estate prices could come later this year, some analysts say, as higher interest rates force speculators from the market and reduce sales volumes. J.P. Morgan forecasts Hong Kong property prices will drop 7% to 12% during the second half of this year. And the Hong Kong economy may slow in tandem with China's next year, which would also put downward pressure on the city's real-estate market, some analysts say.

Not everyone agrees. Some analysts say the market has already priced in an interest-rate rise and adds that any increase would have only a short-term impact on people's decision to buy property. Also, some analysts say rates will be rising from a very low base, blunting the psychological impact of any increase.

However, many analysts expect property stocks to stay around current levels for much of the rest of 2004, as investors assess the market impact on any interest-rate rise and the outlook for China's economy. At current prices, property stocks "should remain attractive" for investors with a longer-term perspective, Ms. Lee at ING says.

ina Keeps Telecoms Waiting on 3G

May 13, 2004; Page B4

Global telecommunications companies waiting for China's go-ahead to build new, advanced wireless networks still are facing delays.

A year ago, many phone-industry executives thought China would have awarded its licenses for high-speed "third generation," or 3G, mobile services by now. But Chinese officials lately have suggested the government is in no hurry to rush the technology to market.

Several 3G trials by Chinese mobile-phone operators won't conclude until August or September, and analysts now believe Beijing might not dole out licenses until early to mid-2005. That means deployments in China, the world's largest mobile-phone market, might not happen until at least a year after that.

Still-developing 3G technology, considered the next big thing in phones, allows people to tap into high-speed Internet services over their mobile handsets, letting them view television clips, hold videoconferences or play online games.

Where 3G services have been introduced, consumer acceptance of the technology has been slow, and some operators encountered technical problems early on with glitchy phones. In Europe, Hong Kong's Hutchison Whampoa Ltd.'s 3G wireless arm first offered 3G service in Britain, Italy and Sweden. However, its 3G handsets were large and heavy compared with most regular cellphones, and their battery life was short.

This year, some of Europe's largest phone companies, including Vodafone Group PLC of the United Kingdom and Deutsche Telekom AG's T-Mobile, are placing large orders for new handsets, which is likely to drive down their prices. Moreover, newer 3G handset models, including some ordered by Hutchison, are smaller and have improved battery life, allowing subscribers to actually use the new 3G services.

In the U.S., Verizon Communications Inc., of New York, is rolling out a high-speed wireless broadband service for laptops in numerous cities this year and next, and the company increasingly is offering handsets that feature data services. Other operators such as Cingular Wireless LLC, owned by BellSouth Corp., of Atlanta, and SBC Communications Inc., of San Antonio, also are expected to invest heavily in 3G services and infrastructure.

Several factors are fueling the 3G delays in China. The country quietly is developing its own technical standard for delivering 3G and may need more time to perfect it before awarding licenses, analysts say. Beijing also is cautious about deploying what many feel is an unproven technology.

All this is frustrating for big telecommunications vendors, because billions of dollars in phone-equipment contracts hang in the balance. Vendors such as Lucent Technologies Inc., of Murray Hill, N.J., and Motorola Inc., of Schaumburg, Ill., Alcatel SA of France, and Nokia Corp. of Finland are counting on fresh revenue streams from China once the government gives the go-ahead for 3G. In most cases, pricey new networks will have to be built to deliver the services.

Phone-equipment companies "have a huge amount at stake as to when this happens," says Craig Ehrlich, chairman of GSM Association, a phone-industry trade group. He is also a board member of Hutchison Whampoa's Hutchison Mobile Communications Ltd., one of the biggest proponents of 3G world-wide.

More worrisome to foreign companies is that continued foot-dragging by the government "gives local vendors time to perfect [3G] technology," and possibly win more business, says Andrew Chetham, a principal analyst with research firm Gartner Inc. in Hong Kong. Home-grown Chinese telecommunications-equipment makers such as Huawei Technologies Co. and ZTE Corp. could be beneficiaries, though foreign companies still are expected to play a big role in any 3G rollout.

"We are waiting," says Nokia Senior Vice President Rene Svendsen-Tune. "We are ready to move on in China."

Foreign companies are nervously awaiting a decision from China on exactly how they will be allowed to deliver 3G services. China is nurturing its own domestic standard for the technology, called TD-SCDMA, even though deployments world-wide have relied on different standards, including one called WCDMA that is popular in Europe.

China, anxious to decrease its reliance on foreign technology and exploit its market heft, has been pushing its home-grown standards for an array of technologies. In the case of 3G, Beijing wants to make sure local phone vendors don't have to pay out-of-the-ordinary fees to foreign companies holding phone-standard patents.

Chinese officials say the government likely won't require phone operators to deploy its own TD-SCDMA standard as a condition for getting a 3G license. Still, officials may offer tax breaks or supportive loan policies to companies that use the standard, says Chen Yuping, an official at the China Academy of Telecommunications Research, part of the Ministry of Information Industry.

"China is pushing domestic standards," Mr. Chen says. "It will encourage domestic products and give more space and support for domestic products than for foreign ones."

That could be troublesome for foreign companies such as Nokia, which is pushing the WCDMA standard in the current Chinese 3G technical trials. "Wideband CDMA is our chosen technology," Mr. Svendsen-Tune says. But the two standards eventually could work together, with TD-SCDMA being used as an "overlay" on WCDMA, particularly in busy urban areas, analysts say.

Motorola and Alcatel make gear that can support multiple 3G standards, including a standard developed by Qualcomm Inc., of San Diego, called CDMA 2000.

Still, foreign companies are anxious to see some concrete deals. "Almost all the vendors have their hopes pinned on big 3G contracts," says Alan Hellawell, an analyst with Lehman Brothers in Hong Kong. With the Chinese government saying it has no timetable for issuing licenses, "we can at least impute it's going to be at least a year from now," he says.

Wednesday, May 12, 2004

China Is Calm
About Evidence
Of Hot Economy

May 11, 2004 2:19 p.m.

BEIJING -- Relatively high rates of growth for gross domestic product, consumer prices and credit in the second quarter would be within the central bank's expectations, the People's Bank of China monetary policy committee said.

In a statement posted Tuesday on the central bank's Web site, the policy committee said such relatively high rates of growth aren't a sign that China's current monetary policy isn't working as the growth momentum has carried through from the first quarter.

Instead, the initial results of the current tightening policy should become visible by the third quarter, the committee said.

China began to tighten monetary policy in late 2003 in an attempt to curb an excessive credit expansion that was helping to finance high levels of investment and drive quarterly GDP growth to a nearly 10% annual rate.

The committee's remarks, which present a fuller text of its deliberations than a preliminary statement in April, suggest China's central bank remains willing to wait until later this year to gauge if existing policies have taken root before considering a tougher response.

Several economists have said the central bank eventually will be forced to raise interest rates for the first time since 1995 in a bid to slow China's economic expansion.

Since September 2003, the central bank repeatedly has increased the amount of cash commercial banks must keep in reserve, limiting money available for new lending.

The central bank has issued tougher guidelines on lending while the banking regulator has beefed up efforts to improve loan management at commercial banks.

China's leadership has intensified its campaign to force local authorities to ease back on the throttle and reduce investment in particularly hot sectors of the economy such as property and steel.

Despite the measures, first-quarter GDP growth slowed only slightly to 9.7% from 9.9% in the fourth quarter of 2003.

Meanwhile, consumer prices rose 2.8% from a year earlier, nudging close to the central banks' 2004 forecast of 3% growth.

The monetary policy committee report conceded that its forecast for new loans of 2.6 trillion yuan ($314 billion) in 2004 would result in the second highest level in China's history.

That outcome won't result in a hard landing for China's economy, the committee said, adding that its new loan target can be achieved.

Tuesday, May 11, 2004

Shares in Chinese Companies
May Not Gain on Global Push

May 11, 2004

BEIJING -- Oil field in Indonesia, television makers in Thailand, blast furnaces in Brazil -- Chinese companies are investing in them all, and the shopping spree will only get bigger.

But is China's push to invest overseas a harbinger of higher share prices for those companies that are leading the charge? Not necessarily, say money managers. In fact, investments overseas frequently presage a drop in share price, as fledgling China-based multinationals find that doing business abroad may be even harder than at home.

"Generally, overseas expansion hasn't been a good thing for investors anywhere," says Ian Beattie of New Star Asset Management in London, which manages more than $500 million in investments in Asia, outside Japan. "It's normally a worrying sign: your company goes abroad because its return on capital is falling at home. But what competitive advantage do you have going overseas?"

Mr. Beattie hastens to add that there are loads of exceptions to the rule. But caution is called for when investing in companies starting to go global, he says.

Announcements of overseas acquisitions by Chinese companies have gathered pace in the past couple of years, feeding expectations that the country's corporations are at the beginning of a long trend. A recent example is an investment by four Chinese steelmakers -- Wuhan Iron & Steel, Maanshan Iron & Steel, Jiangsu Shagang Group and Tangshan Iron & Steel -- in an iron-mining operation in Western Australia, a deal that will guarantee them shipments from BHP Billiton of about $9 billion worth of iron ore.

In February, China's biggest steelmaker, Shanghai Baosteel Group, agreed to set up a mill to make steel slabs with Brazil's top iron ore exporter, Companhia Vale do Rio Doce. Chinese electronic-goods maker TCL International Holdings formed a joint venture last year giving it control of the television and DVD operations of France's Thomson, and followed up that deal by taking over the mobile-phone manufacturing operations of France's Alcatel. And China's offshore oil operator CNOOC, which earlier invested in Indonesia, last year bought a 12.5% stake last year in Australia's Gorgon gas field.

Anticipation of Chinese investment has risen so high that a just-published survey of investment-promotion agencies in 158 countries ranked China ahead of Japan as the fifth-largest expected source of foreign investment in the next few years.

The promotion agencies are clearly getting ahead of themselves. China's outward investments in 2002 were about $2.5 billion while Japan's were a whopping $32 billion, according to the United Nations Conference on Trade and Development, which conducted the survey. China's cumulative investments abroad during the past two decades are about $35 billion, which is on a par with those by Ireland or Portugal -- two countries whose combined population is less than that of Shanghai.

Still, the broader point about the growing importance of Chinese investments abroad makes sense. "Chinese enterprises are at the threshold of becoming major foreign direct investors in Asia and beyond," writes Karl Sauvant, the director of UNCTAD's investment division in Geneva.

But a glance at the forces driving Chinese companies abroad reveals why it isn't safe to assume such investments will translate into stock-market gains.

For starters, investing abroad is now state policy. China's government has been implementing a rash of incentives to get local companies to put money to work overseas as a way of balancing the huge inflows of capital that are exerting pressure on the Chinese yuan's peg to the U.S. dollar. The policy of "zou chu qu," or "venture out," is a good one from a macroeconomic standpoint but hardly guarantees that companies with little experience abroad will make good decisions about where to put their money.

"China has a lot of money burning a hole in its pocket," says Peter Morgan, chief Japan economist at HSBC Securities in Tokyo. But it's when companies are flush with cash that they often make their most fateful miscalculations. Witness the wave of Japanese acquisitions of U.S. office buildings, golf courses and movie studios in the 1980s, which largely ended in tears for Japan's conglomerates.

"The track record for Chinese corporates overseas is too short," says Kenneth Luh, a money manager in Hong Kong. "Even if they're doing the right thing in theory by going abroad, implementation risk is high. You have to look closely at them on a case-by-case basis."

Another factor behind China's outward flow of investment is that it is becoming starved for raw materials and other commodities to feed its expanding manufacturing sector. That has helped push up world commodity prices in the past year and increased Beijing's interest in securing supplies of raw materials. But it underscores the move abroad as often one of necessity, meaning companies may not have the luxury of being able to cherry pick deals.

"It doesn't mean they shouldn't be going abroad, but it usually means that returns on capital at home are deteriorating and that they're trying to find a way out of that," says Mr. Beattie, the London fund manager. He says he has small positions in two Chinese oil companies actively seeking to expand overseas, Sinopec and CNOOC, but admits the rationale for buying them wasn't exceptionally strong.

Mr. Beattie sees some upside in their share prices and agrees with their strategy to look for new sources of gas and oil. But he notes that they are being thrown into competition with experienced oil majors, which could mean lower returns than what they're used to at home.

Monday, May 10, 2004

Limited Price Controls Among Steps by China to Curb Inflation

ONG KONG, May 10 — China took four more steps Sunday and today to slow inflation, including limited price controls in provinces where the cost of living is rising fastest.

The other steps were to require more comprehensive examinations of banks' books, to discourage risky loans; to set stricter limits on converting farm land to industrial or residential use; and to re-evaluate previous government approvals of projects in overheated sectors like steel, cement and real estate.

Beijing's top-level State Development and Reform Commission caused considerable confusion in financial markets today after posting on its Internet site overnight a vaguely worded statement requiring that provinces limit price increases. Officials in four different departments of the commission declined to comment.

By late today, however, business executives and economists were saying that the price controls were limited to already regulated industries like transportation, electricity and water. Harley Seyedin, the chief executive of First Washington Group, a company with headquarters in Guangzhou that owns a large power plant in Dongguan, said that he had spent the afternoon making calls about the announcement and had concluded that it would not extend price controls to any previously unregulated industries.

Beijing has already given permission for two rounds of electricity price increases this year as coal prices have climbed quickly, with the second increase only approved on Sunday, so it was unlikely to have approved any more increases for the rest of the year anyway, Mr. Seyedin said.

"It really is not going to matter much, because those things are going to be regulated anyway," he said.

Liang Hong, an economist in the Hong Kong offices of Goldman Sachs, said that taken together, the latest measures would not address what she described as China's two root causes of overheating investment and rising inflation: an undervalued currency, which prompts heavy speculative inflows of money, and interest rates that are extremely low when adjusted for inflation.

"While we maintain our view of no hard landing in China, the use of blunt administrative measures as a substitute for market-based mechanisms will increase the risk of policy error," she said in a report.

The Hang Seng China Enterprises Index plummeted 7.7 percent here today, its biggest decline in four years. The Shanghai stock market fell 2.2 percent and the Shenzhen stock market dropped 2.5 percent, part of a broader drop by Asian markets as investors responded not only to the Chinese price controls but also to the strong employment figures announced on Friday morning in the United States, after Asian markets had closed for the weekend.

The improving job market in the United States makes it more likely that the Federal Reserve will push up short-term interest rates. Economists said that China would be more likely to raise its interest rates for the first time since 1995 if the Fed acts; for China to raise rates on its own would carry the risk of drawing in additional speculative money that would make it even harder for Beijing to fight inflation.

Today's confusion over price controls was the latest sign of a growing problem. As China has become one of the world's biggest economies and largest importers, its every move has become the subject of minute-by-minute scrutiny in financial markets.

Yet many Chinese government agencies continue to issue vaguely worded statements and then refuse to elaborate, or even issue broad edicts to industries and then refuse to confirm or deny that the edicts were even issued. The China Banking Regulatory Commission issued orders to banks two weeks ago to restrict lending before the May Day public holidays; the agency initially denied it had issued any instructions, then reversed itself and said that instructions had been issued. It still has not published the details of what the instructions were.

China has been struggling with corruption problems at all levels of government. But there have been no cases yet of officials being accused of using opaque agency statements so as to manipulate financial markets for personal gain.

The price control statement called for each province to limit increases if consumer prices rose a full percent from one month to the next, or were 4 percent higher than the previous year for three consecutive months. Even in provinces where prices are rising more slowly, officials were instructed to space out price increases.

One of the biggest economic mysteries these days in China is the true extent of inflation. The National Statistics Bureau has scheduled an announcement on Friday of consumer inflation in China during April. While bureau officials have strongly denied that they have been manipulating the figures, many independent economists are suspicious.

The bureau said last month that consumer prices rose 2.4 percent in urban areas and 4.2 percent in rural areas in the 12 months through March.

Even though two-thirds of the population lives in rural areas, the bureau calculated that this meant that inflation nationwide was 3 percent. That happens to be precisely what China's State Council, or cabinet, has been saying for months is the maximum acceptable inflation rate.

But the few details released by the bureau made it unclear how the rate could be so low. The bureau said, for example, that food prices, the biggest component of the consumer price index by far, were up 7.9 percent. And the main category of food — rice and other grains — was up 10.8 percent.

Separate data from the People's Bank of China, the country's central bank, has shown prices rising at a much brisker pace. The bank's overall index of prices that companies pay for raw materials, intermediate goods like steel and finished goods was up 8.8 percent in the year through March.

Wholesale rice prices were up 33.2 percent, a leap that has particularly alarmed Chinese authorities.

As China Mulls Rate Rise,
Its Banks Are Vulnerable

Increase, First Since 1995,
Could Worsen Problems
For Hard-Pressed Lenders
May 10, 2004; Page A15

BEIJING -- China is expected to consider an increase in interest rates as the next step in a drawn-out campaign to slow the economy's blistering pace, but its banking system remains vulnerable to possible loan defaults due to higher repayment costs.

Market expectations center on an increase of one-half percentage point in central-bank-mandated lending rates, and possibly no change or a quarter-point increase in deposit rates.

Those forecasts have weighed on share prices in Hong Kong, as investors worry that higher borrowing costs could cut into earnings for some listed companies.

A rate increase would be the first since 1995 and would follow eight reductions during the past eight years that more or less halved the benchmark one-year lending rate to 5.31%.

Premier Wen Jiabao, speaking in Brussels on Thursday, likened the economy to a speeding luxury car hurtling down a highway. "It's so fast we can't fully apply the brakes," Mr. Wen said. "We can only touch the pedal lightly to slow down."

China's aim appears to be to slow growth to about 8% this year from nearly 10% in the fourth quarter of 2003 by rebalancing investment away from overheated sectors such as steel, property, cement and aluminum.

An interest-rate increase might be the strongest signal policy makers can send to investors that they are serious about taking some steam out of the economy.

China is weighing its desire to curb credit growth, which is fueling overinvestment, against its concern that higher rates will draw more money into the banking system and exacerbate the problem it is trying to address. Beijing has taken some administrative steps to slow credit growth by tightening lending guidelines and forcing banks to set more of their money aside as reserves.

But fixed-asset investment continued to grow, with most of the capital spending financed by local banks, exposing them to loan defaults if lending rates rise. China's four major commercial banks have high levels of nonperforming loans, a problem that could spread to shareholder banks and city commercial banks if the economy turns sour or rates rise too high.

The administrative controls imposed by the central bank have roiled overseas markets, as some investors fear China might go too far in attempting to slow overall growth and accidentally produce a hard fall for the high-flying economy.

UBS economist Jonathan Anderson said the likely half-point rise in China's lending rate would be a first step, with further increases likely to come.

Tim Condon of ING, who is predicting a quarter-point increase in lending rates, said markets that have been hurt by concerns about the government's response to overheating might be boosted by a less-than-expected rate hike. "We think markets could actually rally on a smaller than expected tightening," Mr. Condon said.

Moody's Investors Service is concerned about the effect of rate rises on China's ailing banking sector. While a slowdown in loan growth may cool the economy, it could create asset-quality problems at the banks, Moody's Senior Credit Officer Wei Yen said in a recent study.

Raising interest rates to slow demand is a double-edged sword, Mr. Yen said in the report. "If the central bank raises the base lending rates, it could slow demand from the fast-growing coastal cities," he said. "But at the same time, it could also create hardship for leveraged [state-owned enterprise] borrowers and penalize borrowers from lesser developed regions in China that are just beginning to see growth."

Friday, May 07, 2004

China Anxiously Seeks a Soft Economic Landing

ONG KONG, May 6 - After a decade with the economic throttle wide open, China is overheating, and the country's leaders are now grappling with ways to slow the breakneck growth without choking it off.

Being able to apply the economic brakes just right to achieve what is known as a soft landing after a spectacular boom is a difficult challenge for any country. It may be doubly so for Beijing's leadership, who are fairly new to the market economy game and who lack many of the finely honed policy tools available to central bankers in the West and Japan. Indeed, economists are deeply split over whether a soft landing or a hard landing is more likely for China.

Prime Minister Wen Jiabao has sought to assure foreign investors that China is taking significant steps to achieve a soft landing. During a visit to Brussels on Thursday, he said that his government would pursue "forceful" measures to "reduce the speed" of the economy "but not a sudden braking." He promised to slow the swift increases in the money supply and in bank lending that have fueled the recent acceleration in growth, but said that a loosening of the peg of China's currency to the dollar would have to wait for banking reforms.

Much is riding on Beijing's efforts. The global recovery now depends on China as one of its twin engines, along with the United States. A hard landing - a steep decline in economic growth leading to higher urban unemployment and a sharp drop in imports - would rattle economies across Asia and around the world.

But it would probably bear little resemblance to the last economic crisis in the region, the cascade of financial and currency collapses that swept through many East Asian economies (but not China) in 1997 and 1998, a memory still fresh and painful for many investors.

If China runs into serious trouble, experts say this would most likely take months to unfold rather than be a financial collapse that becomes apparent in a few weeks, as happened in Thailand, Indonesia and South Korea nearly seven years ago.

"The problem is more of a long-term affair," said Desmond Supple, managing director of Asian research at Barclays Capital. "If we get a hard landing, it wouldn't be anything like" the last Asian crisis.

A soft landing is more probable, say agencies like the International Monetary Fund and some investment banks, with growth gradually slowing to a bit more than 7 percent annually from the 9.7 percent annual pace recorded in the first quarter of this year.

Seven percent a year would still be a scorching growth rate in most economies of some size. But Chinese experts say that is the minimum the country needs just to keep urban unemployment from worsening, as millions of migrants from rural areas pour into cities, straining the social fabric and possibly sowing the seeds of political unrest.

Growth of only 3 percent or 4 percent would feel like a serious economic slump, and zero growth or a contraction would be devastating, the experts say.

"We don't think a really hard landing is a likely scenario" for the economy as a whole, said Huang Yiping, a Citigroup economist in Hong Kong. But there may be crashes, he said, in a small number of industries where overinvestment has been greatest, adding, "You probably will see a very, very hard landing in steel investment."

To avert such a slump, the Politburo as well as the State Council, China's cabinet, have in the last two weeks each issued strong warnings about excesses in large sectors of the economy like steel, aluminum and real estate.

The central bank, meanwhile, has raised bank reserve requirements twice in two months to discourage lending and is strongly hinting at its first interest rate increase since 1995. China's most important step lately, but also the hardest to fine-tune to avoid overdoing, lies in sending the police and prosecutors after local officials who have gone on pursuing grandiose projects despite warnings since June from senior economic officials in Beijing.

Because China lacks functioning bankruptcy laws and foreclosure proceedings, the government must rely on criminal fraud investigations to deal with wayward companies, said Andy Xie, a Morgan Stanley economist.

"Yesterday's entrepreneur is today's 'you stole money, you didn't pay taxes,' " Mr. Xie said, while adding that this approach can chill investment quickly in ways that might be hard to control.

The Chinese economy faces several, more significant structural problems, some experts say. The country enjoys an immense trade surplus with the United States, with its exports exceeding imports by a ratio of eight to one.

But with the world as a whole China has, fairly suddenly, slipped into deficit, in large part because it has rapidly outgrown its domestic resources - raw materials like iron ore and oil - and must now import them at prices driven up by its growing appetite.

Chinese trade statistics, moreover, probably err on the rosy side. Many mainland companies exaggerate their export volume to claim tax credits. Many imports go uncounted because of widespread smuggling to avoid customs duties, which remain steep despite China's pledge to the World Trade Organization to bring them down in stages by 2007.

Although official figures suggest a much milder problem, Mr. Xie estimates that China's true overall trade deficit this year will be around $90 billion - just as big, relative to the size of its economy, as the American trade deficit.

China does not loom large as an export market for the United States. But many Asian nations now depend heavily on selling to China, especially after its overall imports jumped 40 percent last year.

The Chinese accounted for a third of all the growth in Japan's exports, and a similar share of South Korea's, according to Stephen S. Roach, Morgan Stanley's chief economist, and they took two-thirds of the growth in Taiwan's exports. A sharp slowing of growth in China would hit those economies hard.

To finance its trade deficit, China must continue to attract substantial foreign investment. Unlike some Southeast Asian nations before 1997, China relies heavily on long-term investments instead of "hot money" flowing into stocks. Nor does it bear another Southeast Asian nemesis: large-scale short-term borrowing by banks in dollars to finance domestic loans.

Unlike Thailand and Indonesia in 1997, China fully guarantees bank deposits, making it far less likely that the country will see crippling runs on banks by depositors demanding their money. And China still links its currency to the dollar, limits its convertibility into other currencies and imposes restrictions on large capital flows - all steps that insulate it from the global economy.

But bankers here say that the way multinationals are financing their investments has changed sharply in the last two years and can increase China's vulnerability to sudden outflows of capital.

Multinationals used to borrow as much as possible of their investment costs in China from Chinese banks in the local currency, known as the yuan or the renminbi. But more recently, they have borrowed in dollars or euros, betting that the yuan will appreciate in value and make it cheaper to repay their debts.

Because of this change in financing, China has been hit with very large inflows of foreign currency that are being swapped for yuan. The same companies would have the legal right, under Chinese laws, to convert large amounts back into dollars to repay these debts, and might do so if China's economy becomes less attractive.

Even without this risk, the last time China's economy slowed, in 1994, its foreign exchange reserves plunged. Companies resorted to a wide range of tactics, like overcharging their foreign subsidiaries for export shipments, to get money out of the country.

China has immense reserves now; at more than $400 billion they are the second largest in the world after Japan's, and are believed to be invested mainly in United States Treasury securities. But some economists worry about a run on them nonetheless.

"All the elements of a meltdown are evident, including balance-of-payments risk," wrote Carl Weinberg, chief economist of High Frequency Economics, in a report on Monday. "The only question for us is when something might break.''

Others, like Liang Hong at Goldman Sachs, are more sanguine. They suggest that the government can slow some industry sectors, including real estate, without harming consumer confidence too greatly, and without cutting back on investment in infrastructure to address the economy's bottlenecks.

The most crucial bottleneck is electric power. Shortages have become so severe that the Chinese have begun importing power from Russia for the first time, according to a report from the official New China News Agency on Wednesday.

Multinational companies, which do not depend on the country's banks to finance their projects, are still building factories in China at a brisk pace: Volkswagen and DaimlerChrysler each announced plans for additional assembly plants this week.

"We're still seeing a lot of activity," said Michael G. W. Adams, head of Chinese business development for Gammon Skanska, one of Asia's largest construction companies. "In fact, our prospects have increased in recent weeks."

Over all, investment in fixed assets in China rose 43 percent in the first quarter, a pace that makes the American telecommunications and Internet investment booms of the late 1990's look modest by comparison. It took the United States economy several years to work through its excesses when the bubble burst.

The biggest risks are that China will find itself with another very large round of nonperforming loans, in an already limping banking system, and that economic troubles could stir political unrest.

The last true hard landing in China occurred in 1989, around the time of mass demonstrations in Beijing that ended with the killings in Tiananmen Square.

With that memory, Mr. Supple said, "The government's very afraid of the unemployment consequences of a hard landing."

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