We have been following the development of China’s 12th five year plan (2011-2015) with interest, as central government policy is a key driver of China’s economic development and the ability to align investment goals with high-level state objectives has generally been a positive tool for strategic planning. The plan will be announced in March and is expected to outline the following key objectives:
• Increased focus on domestic consumption
• Policies to encourage income redistribution and social welfare
• Industry efficiency and resource conservation
• Focus on increasingly value-added industries through R&D and technology
• Urbanization, inland migration and rural reforms
We believe that a number of these themes will be well aligned with our current investment strategy. In particular, we anticipate a greater emphasis on the development of lesser-developed Central and Western regions as a key method of narrowing the wealth gap and increasing domestic consumption.
CHINESE PRIVATE EQUITY ENVIRONMENT
In January, Shanghai’s Municipal Government announced its long-awaited Implementation Measures on Pilot Program of Foreign-invested Equity Investment Enterprises in Shanghai, which will create a unified authority to manage emerging operational issues related to RMB funds in Shanghai. In short, the measures will relax restrictions on foreign investment into RMB fund entities within Shanghai, an indication that China’s capital markets are liberalizing.
We expect the near-term effects of these measures to be minimal, despite the development of RMB funds being a clear long-term trend. Overall, we remain cautious on the activities of RMB funds in China. The behavior of these funds has disrupted the market in many respects, especially in relation to the valuation of smaller, more speculative businesses. RMB fund’s approach to valuations, due diligence and timing are not sustainable, and therefore we would neither expect nor suggest a rapid inflow of foreign money to these funds.
CHINESE PUBLIC MARKET UPDATE
China’s public markets performed well in Q4, with the SSE up +2.5%, the SZSE up +4.6%, and the ChiNext up +18.5%. Average P/E multiples across the three exchanges also rose during the quarter, from 20x to 22x on the SSE, 32x to 37x on the SZSE, and 64x to 77x on the ChiNext.
Performance was driven by:
– Real GDP Growth – rose from +9.6% yoy in Q3 to +9.8% yoy in Q4, with GDP growth for FY 2010 reaching 10.3%;
– Increased Economic Activity – industrial output growth grew steadily in Q4, up +13.1% yoy in October, +13.3% yoy in November, and +13.5% yoy in December;
– Retail Sales Growth – accelerated from +18.7% yoy in Nov to 19.1% yoy in Dec;
– Urban FAI Growth – up +24.5% in 2010 yoy.
We consider inflationary expectations the most serious threat to near-term economic growth. China’s central bank took steps to limit liquidity during Q4, hiking both its benchmark interest rate and banks’ reserve requirement ratio (RRR) by 50bps. Future hikes are considered likely if inflationary pressures persist.