China needs stimulus boost or slump will continue: Mowat

Menaka: What did you make of that Industrial Production number? In fact even the retail data came in lower than expected?

A: It doesn’t surprise us. We have generally had softer data out of China in the last couple of months and we have been watching commodity prices correct which is probably symptomatic of weaker demand out of China.

Unfortunately, China is trying to achieve a growth rate which is extremely difficult for them to maintain. This is a country with declining working age population and a very high worker participation rate within the working age population. So, you are going to experience this slowdown in growth unless we get another mini stimulus out of the Chinese government which is a possibility and we think if that occurs it will be towards the end of Q2.

Menaka: How much below 7.5 percent do you think the Chinese gross domestic product (GDP) growth will come in for 2014 given that’s the government’s target?

A: We have a forecast of about 7.4 percent for the full year. So, not significantly below but that would require a stimulus in Q3. It is possible that for China on a seasonally adjusted annualized basis growth has slowed to the low of 6 percent. On the year over year basis it will still look okay because we had a very strong quarter in Q3 of 2012.

Menaka: Lower Chinese growth is one thing, we can deal with that given the recovery that’s anticipated in the US and Europe. It’s the volatility the most people are worried about. What you have seen happen with Copper in the last week or so, the first private bond default in China that spooked people considerably, the news that Chinese companies have used copper imports to collateralize some of their loans, all of this is frightening global markets in terms of the kind of volatility they could face this year?

A: There are 3483 corporate bonds in issue only one of them has rating below investment grade. Most people that look at the credit markets in China realize that this sort of rating is probably incorrect.

Just as we have Chinese banks trading at five times earnings with high yields because again the investors don’t believe in the reported asset quality so I don’t think there is too much new news in the bond defaults. We have had very weak old China performance, the old China being asset intensive industries for a couple of years now on significant de-rating. However with regards to commodities financing we did see in 2012 a correction in both copper and iron ore prices because of the unwind of commodity financing transactions.

The way these work is, you take out a letter of credit, maybe 188 days and you import the commodity which is both iron ore as well as copper. You then use that to take out further credit onshore and perhaps use that cash to buy wealth management products. This is well know within the trading communities for commodities, although obviously it is not something that you can get a handle on in terms of statistics because you have almost a fraudulent activity here because you are borrowing twice against the same bit of collateral.

Senthil: In all of this, is the Indian market too insular? We have the NASDAQ having its worst week since almost 2012, the rest of the world is clearly worried. We are hitting new highs in India?

A: Its great news that the copper price, the iron ore price is coming down as India needs to spend more money on infrastructure, you want your commodity import bills to be coming down. We did have some negative news for the Indian IT sector and a relatively poor guidance and we are seeing a correction there. However as we look at the story for the Indian economy for this year, you are coming off a very low base in 2013 and we think there is going to be an ongoing rotation in the cyclical stocks in India as investors price in a better policy environment post the elections.