China's Investment Boom to Continue, Nomura Says

It is one year since China launched its Rmb4 trillion ($585 billion) stimulus package, the country's attempt to stave off the effects of the financial crisis by massively increasing spending on infrastructure. There are worries in the market that if the private sector fails to recover quickly enough, the stimulus money will dry up, and so too will fixed asset investments (FAI).

The market need not fear, said Mingchun Sun, Nomura's chief China economist, since the scope of the package has vastly exceeded expectations, triggering an investment boom that should last into the next few years.

"This investment boom will be a significant milestone in China's economic development," said Sun at a press briefing in Hong Kong yesterday.

Local governments and state-owned enterprises have taken advantage of the relaxation in the project approval process to launch a stack of backlogged projects. There are so many projects in the pipeline that they cannot be paid for by the original Rmb4 trillion, of which Rmb1.7 trillion was to be government money while the rest was to come from banks. And this is borne out by the extraordinary high level of lending this year, Rmb8.7 trillion by the end of September, most of which is thought to have gone to stimulus projects.

Sun's main assertion is that the stimulus spending is not front-loaded into 2009, and that the spending will continue over the next couple of years. In other words, most of the money has not been spent yet. This is because most infrastructure projects are long-term undertakings - it takes years to build a subway, an airport, or a major bridge, he said.

He added that around 75% of the total stimulus investment will come after 2009, with spending set to peak sometime in 2010. Another factor that pushes much of the spending into the future is that the initial stages of most infrastructure projects, such as preparation and land work, are not intensive in terms of investment.

One of the main effects of the prolonged investment boom is that it stimulates consumption. According to Sun, there is a correlation between changes in the amount of bank loans in China and the net financial assets of households. This is because the money borrowed from the bank to fund a project eventually makes its way into the economy in the form of wage cheques. Nomura's rough estimate for the level of consumption growth is more than 15% per annum in the period from 2009 to 2011, compared to a 10.7% average over the past decade.

This will, in turn, put upward pressure on asset prices. An increase in household wealth will make people diversify their assets from bank deposits into things like stocks, bonds and investment funds. The Chinese population has a track record of changing the direction of where its money goes: in 2005, 70% of increased financial wealth went into the bank and 20% into investments. As the stock market rocketed in 2007, bank deposits made up only 30% of new wealth and stocks accounted for 40%. Although this trend reversed again in 2008, it could quickly switch back in favour of investment products as economic optimism takes hold again in China.

Asset inflation will be further encouraged by the presence of excess liquidity and low levels of CPI inflation.

The end result, said Sun, is an asset price bubble that will eventually burst. In the meantime, there are still several years of opportunity to participate in the stimulus investment theme. Nomura analysts have a whole basket of stocks that they expect to perform well over the next few years. On the infrastructure side, the Japanese bank is still particularly bullish on the railway sector, with 'buys' on China Railway Construction Corporation and China South Locomotive & Rolling Stock Corporation. And to take advantage of the asset inflation angle, there are property developers, such as China Resources Land and KWG Properties.