CHINA Interest-rate rise may help investors

A fast-moving economy can handle a tap on the brakes.
CHICAGO TRIBUNE
China's surprise decision to raise interest rates may represent a dramatic shift in how the government tries to manage its surging economy, but several experts said it poses little threat to investors -- and might even offer them opportunities.
Taking a page out of Federal Reserve Chairman Alan Greenspan's book, the Chinese central bank pushed rates 27 basis points higher in late October, to 5.58 percent, in the face of a surging economy and inflation running at more than 5 percent. A basis point is 0.01 percent.
It was the first increase in nine years, and analysts expect more to follow.
China captivates countless investors who consider it the ultimate emerging market. They look at a nation with roughly 1.3 billion consumers and an economy advancing 9 percent a year, and they see gold.
Not always a negative
Rising interest rates, of course, are generally considered a negative for stock investors. But in this case, experts said, an economy moving that quickly can handle a tap on the brakes.
The rate increase, however, does represent an important shift, they said.
"This is only the first rate hike and it sends a signal that the government is willing to use market-based measures of raising interest rates to cool the economy," said Pamela Chan, portfolio manager of Eaton Vance's Greater China Growth Fund.
She said they're shaping up to be "gradual and cautious" increases totaling about 1 percentage point over 12 months.
Some experts anticipate a series of increases that could raise rates 2 percentage points. But Shanquan Li, a portfolio manager at Oppenheimer Funds and former senior researcher at a Chinese government think tank, said he believes the next move is further off than people expect.
"China needs the growth," Li said. "The central government didn't want to dramatically slow the economy. That's obvious."
He said higher rates might slow the pace of new development, but existing projects and consumer appetites aren't likely to be seriously threatened.
"The basic demand is still there. It's very strong," he said.
Indeed, because of the government's central role in managing the economy in China, analysts said the key to slowing its growth lies there.
Guang Yang, senior vice president and lead portfolio manager of the Templeton Global Opportunities Trust, said the government has already taken steps to slow investment in areas with too much capacity and redirect it toward electricity and transportation to reduce bottlenecks to growth.
Return on capital
Having government-run banks simply cut lending sharply overall would be "much more effective than an interest-rate hike," he said, in part because businesses' return on capital is running at 10 percent to 12 percent.
"If they can borrow at 5 or 6 percent, that's still a pretty good deal for them," Yang said.
For investors, exposure to China is often indirect, filtered through companies that supply it with capital goods such as information technology and raw materials and equipment for construction.
China's rapid financial surge, for example, has played a prominent role in the powerful upturn that Peoria, Ill.-based Caterpillar has seen over the past 12 months.
Chinese entities have been buying Caterpillar's heavy equipment to construct new factories, boost mine production and expand highway and rail infrastructure.
In addition, China's hunger for steel, coal and other raw materials has driven up commodity prices, spurring increased activity at iron-ore, coal and copper-mining sites, and fueling a burst of new orders for Caterpillar earthmovers and other mining equipment.
Caterpillar spokeswoman Kelly Wojda said the company has been affected in the past six months by previous government efforts to slow the economy, particularly curbs in construction project spending, although that has been offset by growth in other areas.
"Long term, we're still very positive about the growth opportunity China represents," Wojda said. "If these short-term actions can bring the growth rate to a level the Chinese economy can sustain, that's a positive for our goals in China."
Other area companies with significant operations in China run the gamut from consumer-focused firms like McDonald's Corp. and Chicago-based Wm. Wrigley Jr. Co., to high-tech firms such as Motorola Inc. and Molex Inc.
McDonald's has launched an ambitious expansion in China, and a spokeswoman said the interest-rate increase would not affect it.
"We're very much focused on moving forward with having 1,000 restaurants by the year 2008, which is the year the Olympics are in Beijing," said Anna Rozenich. Currently, McDonald's operates about 600 restaurants in China.
Roughly 10 percent of Motorola's sales last year were in China, where the company has long been one of the largest multinational investors and the country's leading maker of cell phones.
Electronics market
Rate increases are aimed more at capital-intensive industries and are not likely to affect China's surging consumer electronics market, which is growing by more than 20 percent annually, said Cynthia Meng, consultant with market research firm Adventis Inc.
"The driver for consumer demand is coming from the increase in levels of wealth, modernization and urbanization," Meng said.
Asia has been a significant driver of electronic components manufacturer Molex's sales, for example, with sales in its Far East South region, which includes most of China, jumping 33 percent in its recently completed fiscal first quarter. That region's revenue of $190 million topped the $177 million in its Americas region.
Wrigley cited sales growth in China for helping to drive a 23 percent increase in Asian sales in its third quarter.
For other companies, the benefits of Chinese economic growth are less direct. In an October regulatory filing, for example, Chicago-based jetmaker Boeing Co. cited "strong economic growth" in the United States and China in particular for helping to improve global air traffic levels.
Several economists said the true importance of the rate increase is the use of monetary policy to influence the economy.
"There is a lot of significance that they're getting more market-oriented, and that is the biggest impact of any," Cooley said. "I think this is a nudge in the right direction toward being a free-market economy."