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Positive economic outlook for China

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China is shrugging off the financial woes of Europe and the US and China’s long-term growth and economic prospects are positive, says Daniel Murray (pictured), Head of Global Research, EFG Asset Management…

Flexible monetary policy, encouraging intra-demographic shifts and a planned leadership transition will all contribute towards a balanced, growing economy. These long-term positives in China offset short-term difficulties. China has combated its inflation issue by raising the reserve requirements of the Central Bank forcing domestic lenders to increase the level of reserves. This has reduced the growth rate to a current 8.1% for the first quarter this year from 10% in 2011.

China entered the financial crisis with relatively little leverage which helps explain the more normal and forceful recovery in the aftermath. Chinese interest rates have also increased but not by very much. The People’s Bank of China has instead used the Reserve Requirement Ratio (RRR) as a more aggressive means of controlling the flow of credit to the economy, essentially requiring banks to set aside proportionately more cash, thereby reducing resources available to lend out.

The major advantage China has over developed country cousins is that of policy flexibility. We are optimistic that interest rates and RRRs will be lowered further – aggressively if necessary – in response to any meaningful and unexpected economic slowdown.

There is also much greater room to manoeuvre on the fiscal side given the relatively low debt-to-GDP ratio. In turn, greater policy flexibility should ensure that China avoids a hard landing.

In terms of demographics, what China does have to its advantage is the opportunity to exploit favourable intra-demographic shifts. Specifically, we are witnessing rapid internal migration from low productivity rural agricultural to higher productivity industrial sector employment. For example, last year for the first time China’s urban population overtook its rural one, with the former growing at an average annual rate of around 3.5% for the past five years. For as long as this migration continues – and it should for at least the next few years – it will support growth, although the longer term prospects for China’s expansion are limited by the poor aggregate demographic profile.

The fifth generation of Chinese leadership will take the helm in October 2012 and this power change is salient because with the new leaders on stage, the transition towards a more balanced economy will accelerate.

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