Taking a closer look at China

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La Française and JK Capital Management explain 2015 might be a critical year for China as its government is considering financial reforms.

We believe 2015 will be a critical year for China. The rest of the world stands to wake up to the idea that the Chinese government is thinking big and is serious at reforming its economy.

A re-rating of H shares that currently trade at a 30% discount to A shares could be the outcome and the early April rally of the Hong Kong listed shares early April, triggered among other things by the opening of the Shanghai Hong Kong stock connect to mainland retail investors, was a first step in that direction.

The setting up by China of the Asian Infrastructure Investment Bank (AIIB) is a major event.

With China owning half of the equity of the bank and exercising significant influence over it, the new bank’s aim is to finance infrastructure projects throughout Asia that can be served by Chinese industries suffering from overcapacity. India and South-East Asia stand to benefit first.

As these lines are written, 46 founding members declared themselves, from Brazil to Germany and Poland, including die-hard US allies who had earlier followed the US recommendation not to participate (United Kingdom, South Korea, Australia and most surprisingly Taiwan). Japan seems to be the only US ally not to have budged yet.

Alongside the willingness to see the RMB become a global reserve currency, the governor of People’s Bank of China announced this month that a deposit insurance scheme for deposits up to RMB 500,000 would start on 1 May, followed by full liberalisation of interest rates.

Zhou Xiaochuan also told delegates participating to the China Development Forum that Beijing will accelerate financial reforms and strive for full RMB convertibility within 2015.

No economist had ever imagined that full convertibility of the Chinese currency could take place as soon as this year. The setting up of the AIIB was most likely a catalyst.

Macro data
We are in a context of “bad news is good news” in the sense that disappointing macro numbers can only trigger more interest rate cuts and RRR cuts going forward.

China certainly has plenty of room to do so as long as the oil price remains around $50 a barrel.

The one-year official lending rate stands at 5.35% when inflation stood at +2.0% in February. We believe the next rate cut can come very soon as economic indicators point to a GDP growth in Q1 lower than 7.0% compared with 7.3% in Q4 2014.

The official PMI number stood at 50.1 in March vs 49.9 in February when the HSBC PMI that focuses more on the private sector dropped to 49.6 in March from 50.7 in February.

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