Advice on China investment: Follow the government

CRAIG STEPHEN'S THIS WEEK IN CHINA

Advice on China investment: Follow the government
Commentary: Talk of yuan convertibility illustrates why official statements and media may be key for making money
By Craig Stephen

Last update: 4:10 p.m. EST Nov. 23, 2008
Comments: 11

HONG KONG (MarketWatch) -- If you want to invest in China, do not try to pick winners among businesses. Instead, follow government policy.

That was the advice given by one seasoned China private equity investor speaking last week at Hong Kong's annual Venture Capital Forum held at Cyberport. To be honest, I had expected some secret investment recipe from these sage professionals, who invest early for the longer term.

There was more: Read the Peoples Daily carefully, as it often front-runs government policy to gauge opinion.

This advice might seem disarmingly straightforward, but it makes a lot of sense. Let the government anoint the winners and jump along for the ride, be it China Mobile (CHL:
china mobile limited) or Alibaba (ALBCF: alibaba com limited) (HK:1688: news, chart, profile) .

For the future, a couple of sectors at the Forum were highlighted as getting special attention from Beijing, namely health care and clean tech.

Some brokers agree that following the government is a sensible investment strategy. MainFirst, in a new report, says earnings visibility is scarce and the simplest path is to see which sectors benefit from the Chinese government's monetary and fiscal stimulus.

This looks like a timely updates of the "buy what China is buying" strategy. After all, in these cash strapped times it seems only governments have money to spend.

Another way to follow this advice is to watch the mainland Chinese government's external policy. China looks set to assumes a bigger role on the world financial stage, possibly sooner rather than later. Increasingly Beijing is debating policy options as it surveys the damaged financial landscape in the post sub-prime era.

Last week the sacred cow of the yuan currency and its lack of convertibility appeared to leap back on to the policy agenda after being run in the press.

A former deputy governor of the central bank called for China to accelerate moves towards convertibility of the yuan. Wu Xiaoling, now a deputy director with the finance and economic committee of the National People's Congress, said China must move soon.

China's currency today has a crawling peg to the U.S. dollar but is still not fully convertible. It may be bought and sold for purposes of trade and investment, but it's not convertible for purely financial transactions.

This arrangement had been credited with shielding China from the worst of the financial crisis. But as times change, it might also be time for a policy rethink.

The main arguments against change are fears of capital flight, unpredictable moves in the exchange rate, and preserving the value of China's U.S. dollar reserves.

As China recently surpassed Japan as the biggest holder of U.S. government securities, it could be timely to question the wisdom of adding to its mountain of dollar reserves, especially with U.S. authorities looking set to print more greenbacks as more businesses demand a bail out.
Wu was reported to say China's foreign reserve and commercial banks hold US$370 billion of Freddie Mac and Fannie Mae bonds, but that should not stop change -- China could afford to lose that.

Worries convertibility could spark capital fleeing China's shaky institutions should be less of an issue today: They surely stack up a lot stronger against their beaten-down overseas counterparts.

Against that, the benefits of having a fully convertible currency have to be considered. It should be easier to trade in yuan, with contracts in yuan removing a lot of exchange risk. There is also potential to boost growth in China's banks and financial institutions as they diversify.

Not only could China seek to have more diversified foreign reserves, it could also benefit when other countries' central banks hold yuan reserves -- something Thailand recently proposed.
Other media reports suggest China is considering adding more gold to its reserves. Gold is well off its dollar-denominated highs, but it has recently held up pretty well as a store of value in euros and many other currencies.

If China does move, or if it begins the process, it will have major implications for reserve currency weightings, as well as potentially for the Hong Kong dollar, and will lead to increased capital flows.

Of course, the proposal may be merely testing opinion, but it is something to keep an eye on.
Meanwhile, in Hong Kong as the economy continues to decline, some analysts suggest that, here too, government intervention is possible. RBS said in a new research note that the government could intervene to shore up the property market if price falls accelerate, warning of a return of asset deflation.

Hong Kong Chief Executive Donald Tsang recently held a fireside chat with British Prime Minister Gordon Brown, so maybe RBS has a fast track on information. The U.K. government will shortly become the largest shareholder in RBS, in the new world of state-owned investment/commercial banks.

It seems everywhere, we will have to get used to more government intervention in the economy.

And as the balance of power shifts on the global stage, being prepared for Beijing's next moves is going to be increasingly important


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