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China - The Roaring Dragon

After decades of being dubbed as the graveyard for investors' capital, China may finally be ready to deliver sustainable returns. In fact, recent changes have made the home of the dragon the envy of the tigers and most likely the next destination for the bulls.

Thursday, November 27th 2003, 2:24PM

After decades of being dubbed as the graveyard for investors' capital, China may finally be ready to deliver sustainable returns. In fact, recent changes have made the home of the dragon the envy of the tigers and most likely the next destination for the bulls.

Preceding the Asian crisis in 1997, many Asian economies including Malaysia, Thailand, Taiwan and Korea were underpinned by huge inflows of foreign capital rather than domestic savings and investment. The region had established a strategy for attracting foreign investment: liberalisation of the financial sector; maintenance of high domestic interest rates to attract portfolio investment and bank capital; and pegging of currencies to the US dollar to reassure foreign investors against currency risk.

With the help of hindsight, it was a journey to capitalism in the "fast lane" driving a rented Porsche. Foreign capital never found its way into the domestic manufacturing sector or agriculture. Little time was spent on developing infrastructure, corporate governance practices or long-term investment programs designed to construct self-sustaining economies.

The high-yield sectors with a quick turnaround time to which foreign money gravitated were the stock market, consumer financing and, in particular, real estate. Not surprisingly, a real estate glut developed rapidly caused by an oversupply of investment aimed at a population with no money. By early 1997 many investors concluded it was time to get out and get out fast. It was labelled the Asian crisis.

Despite the downturn, the factors that have driven investors into Asian markets in the past are still the same factors that drive them now: low cost of production, raw materials accessibility, skill of the labour force and tax advantages.

China emerges as a contender for foreign investors' capital. Enter China. China took a different approach to growing its economy. During the height of the 1990's boom, when other Asian governments were busy talking about Free Trade agreements, and building the world's tallest building, China was busy climbing up the skill ladder.

China was beginning to change the way they did business. Chinese companies began concentrating on their core strengths; a complete reversal from their previous preference for trying to do everything. They revolutionised their operating philosophies and created more viable business models via mergers and acquisitions, disposals and divestment, provisioning and asset re-appraisals. They were determined to become globally competitive. And the changes are continuing. By opening its markets to other member countries, China is making use of foreign capital and technology to transform its traditional industries and accelerate the development of high-tech industries and services, and raise the corporate governance practices or long-term investment programs designed to construct self-sustaining economies.

By opening its markets to other member countries, China is also making use of foreign capital and technology to transform its traditional industries and accelerate the development of high-tech industries and services, and raise the overall levels of China's industrial development.

China's strong GDP growth to continue

China's entry into the World Trade Organisation (WTO) is expected to usher in a new round of economic growth amid some pains from reform and readjustment in the first year of its WTO membership.

According to a report by the International Investment Bank, China's economy is forecast to grow at an average six percent annually during the coming two decades, and become the second largest in the world next to the United States by 2030.

In the next ten years, China should be able to build on its repeated economic success as it gradually transforms from an agricultural to a manufacturing base. For example, in 1994, garments, footwear and plastics accounted for 29% of exports. They now account for 17%. China is moving up the ladder of skilled manufacturing. In fact, in the first quarter of this year Chinese vehicle production was 54% higher than for the previous corresponding period and car production was up by an amazing 124%. Personal computers were up 95%, air conditioning units up 57%, vacuum cleaners up 33% and motorcycles and refrigerators up 31%.

Brakes applied to make growth sustainable

In recent months the Chinese Government has taken steps to keep its economy from overheating, highlighted by China's central bank raising the reserve requirement on bank deposits from 6% to 7%. While this should slow investments in cyclical industries and property, it shows that the Government is being pro-active to prevent a bubble forming in its economy.

What does this mean for Australia?

The main problem for the rest of the globe is having to embrace China as both an opportunity and a threat. The opportunity is the growth of new and growing consumer demand and the threat is the competition it presents as a low cost producer to the world. For Australia, it means greater demand for our resources, as China has scarce supplies of copper, aluminium, bauxite, nickel, zircon, iron ore, manganese, chromium and potassium. It will also mean greater demand for our intellectual property, which may include such things as engineers for infrastructure developments and accountants for changes to international accounting standards.

« Strategic asset allocation – set and forget or dynamic?Market Review: So far so good for the US – but will it continue? »

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