We are often asked what would change our relatively bearish attitude towards the Chinese economy and equity market, to which our first answer is a credible proposal to reorganise the fiscal relationship between central and local government on a similar scale to what happened in 1994, but with the opposite impact, namely of increasing the revenue base of local government.
This is predicated on the belief that much of the sharp drop in China's productivity growth which has taken place in recent years derives from the reliance of local government on manufacturing industries for social/financial support. The resolution of the underlying fiscal issues around local government is also bound up with reforms to the current system of land ownership and the way in which the hukou or residency permits are granted. There have been some fairly strong statements from the finance minister Lou Jiwei since the start of 2014 that the authorities may be on the cusp of announcing a much clearer roadmap for fiscal reform, but so far nothing has emerged. Similarly there has also been a wave of speculation over the past couple of week concerning the possibility of a major liberalisation of the regulations concerning the system of granting hukous, but a clarifying statement has made it clear that any shift can only occur on a city-by-city basis. We will continue to scrutinise policy statements towards both fiscal and land issues very carefully, but so far Beijing appears to be continuing its recent tradition of talking up expectations, which are subsequently not backed by tangible measures.
The anti-corruption campaign has also become an increasing area of focus for equity investors as it has been steadily increasing in intensity over recent weeks. The sharp rally in the price of Petrochina in particular, has been partly in response to the potential impact of the allegations of corruption made against senior figures at the company, in causing a re-evaluation of the capital expenditure programmes, which have been perceived as value destructive by minority investors. We are sceptical that there will be much in the way of change, since most of the big downstream projects which were undertaken within China and overseas appear to have reflected the strategic priorities of the Chinese state, priorities which are unlikely to change much over the near future.
The efforts to give Hong Kong residents greater access to the mainland market and mainlanders access to the Hong Kong market, in addition to veiled stimulus loans to the China Development Bank, have stoked interest in the A-Share Index. If these are additionally associated with long awaited progress in reforming the hukou residence system or the further rollout of a property tax, the recovery potential of the market would be enhanced as it would represent a considerable improvement in governance.
The opening up of the Hong Kong market to mainland investors has been a catalyst for the recent rally by the Hang Seng which is currently testing the 2010 high near 25,000. Some consolidation in this area is likely but a sustained move below the 200-day MA, currently near 23,000 would be required to question medium-term scope for additional upside.
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