China To The Rescue

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This story features FORTESCUE LIMITED, and other companies.
For more info SHARE ANALYSIS: FMG
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Andrew Nelson

Over the weekend, the Chinese government announced a major new economic stimulus package amounting to approximately US$585 billion to be spent over the next two years. The package, aimed at keeping Chinese GDP above 8%, includes funds for roads, health services, rural infrastructure, domestic transport systems, low-cost housing, food subsidies and post earthquake rebuilding in the Sichuan province, and more.

On numbers from Danske Bank, the total size of the stimulus package is about 14.5% of China’s GDP based on 2008 estimates, or roughly 7% of GDP in spending per year.

The problem is, it’s not known how much of the money is actually additional money to what had already been promised. Standard Chartered points out that over the last few weeks, several spending plans have been announced, including accelerated spending on railways and a proposed CNY 5trn spend over five years on the nation’s road network. There have also been other measures, such as more VAT export rebates and measures to encourage house buying.

With Chinese infrastructure spending already at an estimated US$725bn per year (Merrill Lynch estimates, July 2008) over the next three years, it will be next to impossible to untangle whether this is entirely new money.

China Strategist and Chief Economist for JP Morgan, Frank Gong, suggests the ultimate plan for this fiscal stimulus package is to demonstrate that a macro policy response to contain the downside risks for the Chinese economy over the next few years has been implemented. The purpose? To help easing market concerns that China’s economic growth could slip below 8% in 2009.

Standard Chartered economists agree, saying this kind of announcement is important to prevent overall sentiment from deteriorating further and that a strong and public commitment to spend through 2009-10 will help stabilise the economy. In short, says Standard Chartered “the statement is clearly an attempt to change the tone of public debate and to raise confidence in the government’s willingness to support the economy through spending.”

New money, old money, real money, fake money, what’s the difference as long as China is prepared to spend and spend big and wisely to keep the wolf that is sub-8% growth at bay. And if that wolf is kept at bay, it spells good news for Australia, especially for the beleaguered resources sector.

Given that the PBoC Governor, Zhou Xiaochuan, said over the weekend that GDP growth in 2009 will be between 8-9%, we’re off to a good start.

JP Morgan thinks the best placed commodities sectors will be steel related, like iron ore and coking coal, as well as copper, zinc, aluminium, and zircon. The stocks best leveraged to a pick-up in these sectors are the large diversified miners like Fortescue Metals ((FMG)), OZ Minerals ((OZL)) and Iluka Resources ((ILU)). Newcrest ((NCM)) is also set to benefit, says the broker, through its copper production.

An increase in construction activity could also translate into higher energy demand, says JP Morgan. This could have a positive influence on thermal coal prices over the short-term, brightening the prospects for companies such as Centennial Coal ((CEY)).

There’s bad news for Alumina ((AWC)) though, as while the broker does expect an increase in Chinese aluminium demand, it thinks the current surplus of domestic Chinese metal production capacity will be more than able to fill the gap. The broker also doesn’t see any near term benefit for gold or uranium demand given the former has limited industrial application and the latter has an inherent lag for the building of new power stations.

However, analysts at UBS offer a sobering thought, being that while China is now riding to the rescue of the world with this stimulus package over the next couple of years, the focus is on investment in infrastructure and consumption. While the broker thinks it will no doubt compensate for some of the weakness in the economy, it will not compensate for all of the weakness. This sees the broker not buy into the 8%+ rhetoric, instead sticking with its forecast for 7.5% growth in 2009 despite the plan.

Danske Bank agrees somewhat with the UBS view, pointing out it will take quite a bit of time for the funds to flow through the economy, so the package won’t make much difference in the short run other than providing a bit of confidence for financial markets. Given the next two quarters are looking pretty tough, economists at Danske see GDP growth probably dipping below 8% for a while. All in all, however, economists at Danske believe they will only need to trim their currrent 2009 target of 8.8% slightly.

JP Morgan argues that China has got the money and is the best positioned in the world to fend off the impact of the current financial storm and focusing on the domestic economy. As such, says JP Morgan, domestic spending is the right starting point. “Stimulating end demand in our view is the key for China to hold above 8% growth on yoy basis,” in the stockbroker’s view.

Standard Chartered agrees about the support for GDP, saying that while it still needs to see more detail to know if its interpretation of the announcement is correct, it believes the package could add up to 3.5 percentage points to real GDP growth in 2009. Standard Chartered economists would like to see more details about the announced investments before jumping to any conclusions in the short term.

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