While the China market may have performed relatively well in 2003, it was a laggard in 2004, disappointing investors who had just earlier invested in the market, on the promise of its economic importance to the region and the rest of the world. Our research desk believes that despite the recent under-performance, the growth story for world's most populous country is far from over.

Looking forward, we are most positive on the China market. Though there may have been earlier speculation on whether the economy was in for a hard or soft landing, it is now more apparent that the government is open to making use of market-based mechanisms such as lowering interest rates as a means to slow down the economy. With China emerging as an increasingly important market and driver of growth in the Asia region (China is overtaking the US as the largest export market for many Asian countries), we believe that China will likely do well in 2005, after a lacklustre performance in 2004.

Below we bring you snippets of news on China, and tell you what to make of these developments.

• Further Measures By China To Further Cool Down Economy
• China Forecasts Economy to grow 8% & Inflation Aimed To Stay at 4%
  
• CHINA ECONOMIC DATA RELEASES:
  Retail sales increased 15.8% y-o-y in Feb 2005
  Fixed asset investments in urban areas increased 24.5% y-o-y in the first two months of 2005
  Foreign Investments picked up by 8.2% y-o-y in Feb 2005
  Industrial production Gained 20.9% y-o-y in Jan 2005
  Export growth Picks Up By 30.8% y-o-y in Feb 2005

1. Measures Used By China To Further Cap Economic Growth

Early March 2005, China said that it would tighten rules on land use and power plant construction to prevent a rebound in inflation and further slowdown it's economy. The government would maintain the macroeconomic controls put in place last year to reduce economic growth to 8% from an eight year high of 9.5% in 2004. Inflation rates averaged 3.9% in 2004 and its housing prices rose by an average of 9.7%. The government aims to limit consumer prices growth at 4%. More recently, China's inflation rose to 2.9% in the first two months of 2005, which signals a slowdown.

The Ministry of Land and Resources says that land conservation will be "a priority" this year. They are strengthening investigation of illegal land use, controlling supply of construction land and boosting protection of farmland. The government of Shanghai said that it is imposing a 5.6% tax on profit from the sale of new and second-hand apartments in the first year of their purchase. This move is directed at cooling price increases in the fastest growing property market in China. In addition, the government plans to increase spending at a slower rate and sell fewer bonds for infrastructure this year to help cool the economy.

2. Growth In Fixed Asset Investments Higher Than Expected

Fixed asset investments in the urban areas of China increased 24.5% year-on-year in the first two months of 2005, according to China's National Bureau of Statistics. Typically, economists look at the combined figures for the first two months of the year to allow for distortions caused by the changes in the timing of the weeklong Lunar New Year holiday, which was in February this year. Year-on-year figures would be based on comparing the figures in the first two months of 2005 vis-à-vis the same period in 2004. Fixed asset investments are an important indicator of how effective the government is in slowing down the Chinese economy. This indicator is expected to continue to slowdown as the Chinese government takes on more measures to cool down selected sectors of the economy.

Accumulated foreign direct investment (FDI) rose by 8.2% year-on-year in February 2005, according to the Ministry of Commerce. As one of the world's biggest domestic markets for mobile phones and motorbikes China attracted US$60.6 billion worth of FDIs in 2004 and the commerce ministry predicts a similar amount in 2005. Although, we see a gradual slowdown in the foreign investments, this portion of the economy is expected to accelerate in growth as automobile companies and retail related companies build up bases in China. To make use of the cheaper cost of labour, automobile companies such as Ford Motors, DaimlerChrysler AG laid out plans to build passenger vehicles at a new plant in Beijing. In addition, MacDonald's and Wal-Mart are also eyeing the large consumer base in China by opening up more stores, especially in the urban areas.

3. Retail Sales & Export Growth Still Strong

Both internal and external demand is still growing strong at double-digit levels. Retail sales climbed 15.8% year-on-year in February 2005 and exports grew 30.8% in the same period. Consumer's demand for food products, cosmetics, mobile phones and automobiles are experiencing a growth trend. This is especially so in the urban parts of China, where residents are getting more affluent. If consumers' spending is growing at such a healthy rate, we think that there is little cause for worry about the prospect of a hard landing in the economy.

Exports, another driver of growth in China, grew 30.8% year-on-year in February 2005. Technology shipments jumped an average of 27% in January and February 2005 and sales of electrical equipment rose 30% during the same period. According to a Bloomberg report on 10 March 2005, after global textile quotas were scrapped on Jan 2005, textile exports are expected to increase by 15% this year. We can see a notable trend that shipments of high-tech products and electrical appliances are improving strongly and might take up a greater part of China exports in the medium term.

Conclusion

Many indicators are pointing to continued growth in China, for example, indicators such as exports growth and retail sales. So far, tightening measures implemented in 2004 had been effective in curbing growth in fixed asset investments and loan growth. Thus, worries on the potential of a 'hard-landing' receded. However, there are still concerns on overheating in selected sectors, especially the property sector in the more developed urban areas of China such as Shanghai. Recently, the government took on a targeted effort to discourage property speculation in Shanghai by imposing a 5.6% tax on property owners who sell within the first year of purchase of the property. The estimated PER is now about 11 times and is in the lower range of valuations within the past two years (see chart above). We like China because we think that fears of overheating have subsided and more measures are taken up by the government to selectively curb certain sectors in China. We think there is strong potential for China to perform well in the next two to three years.

Excerpted from FSM Bi-Weekly Updates (click here for the full text)