Will Sub Prime Choke Growth in China

The HK stock market fell over 3,000 points over the past 5 days. Yesterday, 16 January 2008, it fell 1,300 points. The HKEx shares fell from a high of HK$268 to HK$170.

There are 2 main factors at work: concerns over the impact of the sub prime crisis in the US, and tightening of monetary measures by the PRC authorities.

Sub Prime Crisis
The sub prime crisis will take some time to work its’ way through. There is a real problem in that the underlying assets may not be as good as it should be because mortgage originators have been cutting corners and lending to unqualified borrowers. However, the extent of the problems in the financial market is magnified by the fact that there is no market for the CDO’s securitized by mortgages regardless of the quality of the underlying assets.

So far, we have seen financial institutions writing off tens of billions of US$. There have been delinquencies in mortgage payments but not to the extent suggested by the financial markets which have over reacted as usual. Just because Merrill Lynch (US$15 billion) and Citigroup (US$18 billion) have had to write off tens of billions of US$, the market is expecting every bank to have to do the same.
JP Morgan has just announced write-offs of less than US$1.3 billion much less than Merrill or Citigroup.

Tightening in China

The Chinese government announced that the banks reserve ratio will be further tighten to 15% in an attempt to rein in inflation. In a mature economy where the deposit base is stable, increasing the reserve ratio will mean less money can be lent out. But in China where the deposit base is growing at double digits, increasing the reserve ratio will very little impact on banks’ ability to lend.
The current impact is temporary and mostly emotive. When banks in China start announcing their results we will see that they continue to expand their lending.
Impact on Exports to the US.

Some people are concerned that exports to the US will fall because the US economy may go into a recession. In looking at exports, we must remember that only a small component of that is value added in China. The rest are raw material and energy costs. Therefore, we cannot compare the entire value of exports to GDP (which measures value added) as some have done.

Using only value added in China, exports are not a large component of GDP. In fact with the Chinese economy expanding at double digits, any shortfall in exports may be made up for by increased domestic consumption.

Conclusion

The present correction represents an opportunity to buy into the market at attractive levels. I particularly like the Chinese financials, and the HKEx.