China Industrial Primer
Comment of the Day

August 28 2013

Commentary by Eoin Treacy

China Industrial Primer

Thanks to a subscriber for this educative report from Deutsche Bank covering the environmental sector. The full report is posted in the Subscriber's Area but here is a section
China's urgent need for pollution abatement is driven by the increasing social loss associated with pollution. Figure 1 and Figure 2 depict the country's pollution rate in terms of water pollution. They show that despite the already poor quality of China's underground water, the situation has not been improving, and in fact got worse in 2012. This is not a surprise, as 90% of China's cities have their underground water heavily polluted by industries discharging wastewater directly into rivers without being treated. This problem is exacerbated by China's water shortage problem.

With the surge in PM2.5 in major Chinese cities, many people have begun to pay attention to where China is ranked in comparison with other countries (Figure 3). This was plotted by Donkelaar and Martin using the five-year average data from NASA (2001-06). The data show that China has the highest density PM (approaching 80) compared with any other country in the world. It is now known that North America, most of Latin America, Australia and New Zealand, and Russia have their PM2.5 at or below 15. In a 2010 survey conducted by the Ministry of Environmental Protection on China's pollution situation in over 338 cities in the country, more than 70% of the cities were classified as polluted after they failed the Chinese air cleanliness assessment, and 40% were classified as heavily polluted.

Eoin Treacy's view Anyone who has visiting China in winter will be familiar with how poor the air quality is and the disastrous impact this has on the nation's health. The fact that the administration has made improving air, earth and water quality a national priority is to be welcomed and is likely to also create a number of investment opportunities. I last reviewed Hong Kong listed environment companies in Comment of the Day on August 13th.

In what has been an inclement environment for Asian equities over the last couple of months, the Chinese mainland has outperformed. Among the clear distinctions between China and some of its neighbours are the comparatively attractive valuations on the mainland and in Hong Kong as well as the relative strength of the Renminbi.

Rationalising some of the country's heavily polluting sectors, not least some State Owned Enterprises (SOEs), is likely to form part of China's efforts to clean up the environment. In order to do this some bold decisions will need to made and unpopular policies enforced. Whether China can accomplish this feat and sustain growth without recourse to a weaker currency is open to debate.

The US Dollar has lost downward momentum somewhat against the Offshore Renminbi but a break in the medium-term progression of lower rally highs would be required to confirm a change of trend.

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