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China bulls see MSCI rerating as good omen

TOKYO: To listen to China bulls, the country's reweighting in one of Morgan Stanley's key indices of Asian stocks is a belated coming of age that should be just the start of things to come.

Despite heightened political uncertainty over Taiwan, they said progress with structural and financial reforms plus the economic benefits that will come from joining the World Trade Organisation justify a rerating of China's investment potential.

"China has tremendous prospects, not because it has more than a billion people but because the leadership is committed to reform, it's got the capacity to deliver reform and it's actually doing it," said Frances Perkins, director of the Australian Foreign Ministry's East Asia Analytical Unit in Canberra.

Perkins, a long-standing China optimist, acknowledged the daunting economic and political challenges facing Beijing, first and foremost the need to find new jobs for perhaps 100 million surplus workers in state-owned enterprises.

But she said: "If you look at the countries that have come through that stage of development, they are doing as good a job as any in the region. So perhaps the rest of the world is now seeing that and accepting that."

Perkins was commenting on the economic background to last week's decision by Morgan Stanley Capital International to raise China to almost 10 percent of its AC Far-East Ex-Japan stock market index as of June 1.

China currently makes up less than one percent of the index, the regional benchmark most closely tracked by fund managers, and Andy Xie, an economist with Morgan Stanley in Hong Kong, said its weight can only grow as more big Chinese firms come to market.

"I think this story is far from over and it's going to have massive implications for fund managers," Xie said.

"I wouldn't be surprised if China alone has 20 percent of the weighting in two years' time."

An institutional fund manager in Singapore said he was bullish on China because the cyclical downturn in the economy was bottoming out and a long period of falling prices was ending.

Moreover, the balance of payments was strong and banking risk was diminishing as bad loans are tackled.

"So given this kind of outlook and further liberalisation of the stock market, it makes every sense for MSCI to give China as big a weight as possible," the fund manager said.

He disagreed with those economists who expect Beijing eventually to devalue its yuan currency, arguing that several years of deflation had already given China a strong competitive edge by effecting a devaluation of its inflation-adjusted exchange rate.

"With the stabilisation of the renminbi (yuan) and the Chinese banking system, the whole Asian system has been stabilised. That was one of the main swords of Damocles hanging over post-crisis Asia, and that's been removed," he said.

Charles Pigott, who tracks China for the Organisation for Economic Cooperation and Development in Paris, agreed that, with exports picking up, the currency does not look overvalued.

"There's no compelling case based on external considerations for a devaluation," he said.

On the reform front, Pigott said efforts to reduce excess capacity and overmanning at state-owned enterprises should result in better financial performance over the next couple of years, while banks had shown a marked improvement in lending standards.

"Significant progress has been made. Sustaining it is really the challenge and that is going to take continued efforts."

Perkins believes China's accession to the WTO will be crucial to sustaining the momentum of reform. Talks to overcome one of the last hurdles to membership, a bilateral deal on market opening with the European Union, are due to resume soon.

"The reformers who've been pushing all these policies will be reinforced because they'll be locked into international trade law and they won't be able to backtrack. In fact they'll have to keep moving forward rapidly, which will be to China's tremendous advantage," she said.

Injecting a note of caution, Xie said he was concerned that investors were being too optimistic about the political fallout of last weekend's presidential election in Taiwan.

President-elect Chen Shui-bian has played down his party's pro-independence stance since his victory ended half a century of Nationalist rule.

But Xie said the party's stated mission to set up a separate state put a question mark over the "one country, two systems" formula that has framed Beijing's approach to Taiwan since 1978. China regards Taiwan as a renegade province and has threatened military action if Taipei declares independence.

"We are at a crossroads in terms of regional stability. There's no doubt that the One China issue is hanging in the air and is far from being resolved," Xie said.-Reuters