MOSTLY CHINA

[frenchee]

Commodity Investing
Signals From China
Donald Straszheim 03.09.08, 6:00 PM ET


The National People's Congress (NPC) of China is meeting for an annual event in Beijing--an amalgam of the U.S. State of the Union address, a joint session of Congress, U.S. political convention and real discussion groups.

The NPC confabs bear watching because they signal what is really on the leaders' minds. At the top of China's agenda at present is the nation's too-hot economy and too-high inflation.

The NPC meetings involve a lot of "speechifying," networking and discussion. China's political and governmental decision making is very much consensus-driven; neither ideas nor individuals on the fringe get very far. Advancement of an idea involves getting other officials behind it and working the system (selling the idea, recruiting allies, building a support group) from the inside out.

There is real debate at the NPC meetings, but China's NPC largely ratifies many earlier decisions on important issues--legislation, election, removal, as well as social, political and economic items.

Chinese Premier Wen Jaibao set four 2008 government targets in his opening address: improving the economy's structure; lifting productivity; raising energy efficiency; and environmental protection and remediation. These are broad, consensus targets--hardly items of potential disagreement. But more specifically, economic growth that is too hot and inflation that is too high remain Beijing's dominant focus areas.

Premier Wen announced an 8% gross domestic product growth target for 2008. Don't be misled; this is boilerplate--Beijing would be unhappy with growth this low. China has specified an 8% target the last three years while actual real GDP growth has been double-digits for the last five years.

The 8% "target" is a directional guide to the bureaucracy--Beijing's way to stress the importance of the "quality" of economic expansion rather than just emphasizing its speed. It reminds us of the risk of potential economic overheating. China is comfortable with the 9.4% cumulative annual growth achieved since 1995, although alarmed at the 11%-plus of recent years.

Despite the premier's caution, I believe that my own 8.9% China real GDP growth forecast for 2008 would upset Beijing--too cold, not too hot. As a consequence, I see an end to monetary tightening in 2008 and a temporary halt to the recent, very rapid currency appreciation. If growth in China slows uncomfortably, Beijing will no longer risk its all-important export industry with further currency appreciation and less-affordable exports.

The head of China's central bank has said recently that inflation is China's most important challenge. Beijing set a 4.8% inflation target for 2008, the same pace as in 2007, after China's consumer price index (CPI) climbed to its decade high of 7.1% in January. Since they haven't been very successful to date, look for more little administrative steps to control prices--encouraging imports of essential commodities, controls on various exports, more sales from government stockpiles, and subsidies to farmers to encourage production.

In my view, the 4.8% target for 2008 is out of reach. China is changing from a net crop exporter to an importer. Global grain stocks are down 50% since 1997. I see China's CPI, averaging 6.5% for the total year, concerning.

Neither energy nor the environment has been much discussed at the current NPC meetings, but they are well known to be enduring matters of high importance. China wishes to reduce its reliance on shaky imports of energy products and is working on ways to gain access to secure sources of fuel for the economy.

Its energy industry is also working, driven by the state, to twist the economy's structure toward more energy efficient industries and sectors. And the environment is never very far from consciousness--because it is so despoiled. I expect the NPC to ratify and drive home these points in the next few days.

The so-called "through train" program, which China proposed in August 2007 (and then announced a delay in November 2007) is on hold indefinitely. The program would have allowed Chinese citizens, for the first time, to buy stocks in Hong Kong--in other words, "overseas."

Part of the earlier motivation for the plan was to cool the bubble-like Shanghai stock market. That market, largely closed to outside investors, is down 30% from its all-time high in October 2007 and down 18% year-to-date. It is probably months still before this program gets revamped and actually launched. Quite frankly, how the Hong Kong market does is of little interest to officials in Beijing.

Two other items deserve highlighting. First, government restructuring to reduce bureaucratic redundancy and improve efficiency is always a topic. How the government arranges the chairs is important--but rarely decisive. And second, a new official needs to be named to replace retiring Vice Premier Madame Wu Yi (U.S. Treasury Secretary Henry Paulson's counterpart) in charge of the financial sector.

Most in Beijing would agree that the financial sector remains China's weakest link. And most every China-watcher would agree that filling Madame Wu's shoes is a tall order, but nothing will be more important to China in the coming years than continuing to develop a modern, robust, transparent financial sector.

Donald H. Straszheim is vice chairman of Roth Capital Partners in Los Angeles, former global chief economist at Merrill Lynch, a visiting scholar at the University of California-Los Angeles Anderson School of Management and a longtime China specialist. He previously served as president of the Milken Institute and joined Roth in 2006 to spearhead the firm's China initiatives.