China Equity Strategy
It’s a Liquidity Battle – Bank Recapitalizations vs. Hot Money
 Recovery is well on track — China is well positioned on the recovery track for
2010, in our view. Loan growth estimated at 18-20% (reaching RMB7-8 trillion)
should mean liquidity remains ample. FDI growth could decelerate somewhat, but
with an improvement in quality. Rising income and favorable policies should lead
to a small acceleration in private consumption. The external sector remains the
biggest uncertainty; yet exports should rebound in the double digits given
expectations of 3-4% growth in global GDP.
 Bank recapitalizations are key overhang – Annual new lending of RMB7 trillion or
more will be needed to fund existing projects over the next 3 years, in our view.
Quick and smooth bank recapitalizations could ensure: 1) continued loan growth;
2) no significant NPL problem for another few years; and, most importantly, 3)
only a small risk of a double dip in China’s economy, regardless of what happens
to the rest of the world. Such fund-raising could be a short-term market overhang.
But once removed, bank stocks would likely drive a further re-rating of the market.
 RMB direction is likely to be the focus for the next 6-12 months — Amid an
otherwise stable recovery process, one major uncertainty is RMB policy. Pressure
can be expected to intensify, especially from China’s emerging market peers, for
the RMB to resume an appreciation trend. With the government hesitant to move
the currency aggressively, a gradual appreciation could further build up hot
money expectations, which in turn could lead to another asset price bubble.
 Policy flexibility is much reduced compared to 2004-07 — If an asset bubble does
materialize, the government would have fewer policy choices than in the previous
cycle. A vast expansion in the number and size of physical projects underway
limits the scope for cuts in overall lending levels. Also, persistently low interest
rates in the US make it difficult for rates to be hiked in China.